Contributed by: Nick Defenthaler, CFP®
This is obviously a very common question people will ask and the typical response you will get from most financial professionals is 10%. While this is certainly a good number to shoot for, many clients, especially younger ones, simply do not have the capacity to currently hit this figure. This can become frustrating for some because they may feel like the target of 10% is so far off that it can be deflating and can actually deter retirement savings all together because they feel as if saving a number much lower simply won’t make a difference. More and more recently, I have been recommending a slightly different approach that many clients have been very receptive to and find it far more realistic to implement – the “one per year” strategy.
When a 25 year old is just starting their career, saving 10% of their income most likely isn’t feasible. Between student loans, housing, transportation, utilities, groceries and other discretionary spending, someone in this age group might be lucky to contribute 3% - 5%. My suggestion for these younger professionals is to start saving 5% into a retirement plan (typically around the most you need to contribute to get the full company match if your employer offers one) and increase the percentage by 1% each and every year until you hit 25%. By age 30, retirement savings would be at 10%, 15% by age 35, 20% by age 40 and eventually hitting 25% by age 45. Does this mean you shouldn’t save more than 25% once you get there? Of course not! If you have the available cash flow, we will almost never discourage our clients from saving more but most clients find it tough to save beyond this percentage. If you’re getting a later start on retirement savings, this doesn’t mean you can’t use “one per year” strategy. The key is to make progress and if you can eventually be saving between 20% - 25% of your income in your fifties (when most are typically in their peak earning years) you are putting yourself in a fantastic position in those crucial years leading up to retirement.
By increasing savings gradually, it makes retirement savings far more manageable and realistic for many. Think about it, if you’re trying to lose 100 pounds and you become fixated on that large number, chances are you’ll become overwhelmed and give up on your weight loss goal. The people who have the most success are the ones who focus on small victories. Losing a few pounds per week until that goal is met– the same goes for retirement savings.
I personally use the “one per year” approach and have found it extremely helpful and motivating. More and more 401k plans are now offering the option to enroll in an “auto increase” where this 1% bump occurs automatically so you don’t even have to worry about remembering to make the change online each year. This is the ideal so ask your HR department if your plan offers this option. When you increase your savings by 1% each year, you honestly don’t even notice the difference, especially if you’ve received a modest pay raise. Often times that miniscule annual increase is the equivalent of one less Latté or lunch out per week – something I think we can all manage! Keeping it simple and being consistent is my advice, which is what the “one per year” strategy is all about!
Nick Defenthaler, CFP® is a CERTIFIED FINANCIAL PLANNER™ at Center for Financial Planning, Inc. Nick is a member of The Center’s financial planning department and also works closely with Center clients. In addition, Nick is a frequent contributor to the firm’s blogs.
This material is being provided for information purposes only and is not a complete description, nor is it a recommendation. Any opinions are those of Nick Defenthaler, CFP® and not necessarily those of Raymond James. The information has been obtained from sources considered to be reliable, but Raymond James does not guarantee that the foregoing material is accurate or complete. Investing involves risk and investors may incur a profit or a loss regardless of strategy selected. Prior to making an investment decision, please consult with your financial advisor about your individual situation.