Saving for retirement may seem impossible when bills and other short-term financial goals control your budget. Poor financial decisions and saving obstacles also make it very easy to get sidetracked from your retirement goals. You might be asking yourself how it is possible to focus on retirement when there are so many other day-to-day living expenses.
You might also question if it’s really necessary to get started now. You probably have many years to go before retirement and considering how little you can contribute; you’re probably assuming that it won’t make a significant difference.
However, saving for retirement as early as possible makes a huge difference and should be practiced even if you are earning a minimal income. A frugal mindset along with the right tools and knowledge is all it takes to get started on a successful retirement plan. Here are some guidelines to get you started.
Compound Interest Over Time
Compound interest is the main reason why it is important to get started on your retirement fund now instead of waiting until you think you are in a more financially secure situation. It is also the reason why debt feels like it takes so long to pay off.
In simple terms, compound interest can be described as building interest on your interest. This means you are receiving interest on not only your initial investment, but also previously accumulated interest.
Here’s an example: Let’s say you invested $100 into your retirement account last year and earned an 8% return. That means you will have $108. This year, you will earn interest on the $108 in your retirement account instead of just your initial $100 investment.
That increased investment will continue to grow and is the reason why it is so important to get an early start. Leveraging compound interest and time to your advantage will allow your investments to grow to their full potential and maximize the money you are putting towards your retirement fund.
Essentially, you are maximizing the money you are putting in towards your retirement fund just by getting an early start.
Get Rid of Your Debt
In the same manner compound interest accumulates for retirement funds, compound interest for debts and loans can also snowball. One of your priorities should be to make a budgeting or savings plan to pay off any debt you might have. This can be done before or during your saving for retirement, but really depends on how much you owe.
For example, the average return for a 401(k) ranges from 5% to 10%. If you have thousands of dollars in credit card debt with say a 26% interest rate, you are taking a loss by carrying a balance than you would profit by investing that amount into your 401(k). In this case, it would be better to pay off your credit card debt before raising your 401(k) contribution. However, if you do not have any high-interest debt, it might be better to pay off your debt or loan slowly over a longer period of time while putting more money into your retirement fund.
Make a Budgeting Plan and Stick with It
One thing that seems pretty obvious to do, but happens more than we think it does is not making a budgeting plan. Many people spend more than what they actually have, which is a huge problem. Spending money unnecessarily and using credit cards too often can easily place you in debt that can quickly snowball out of control with negligence and high interest. Not buying more than you can afford, spending less, and setting aside savings funds will alleviate this bad habit.
What works for me is writing a list of all my monthly expenses. This includes things like rent, car payments, utility bills, food costs, and nights out. From there, I’ll brainstorm ways to reduce and cut these costs. For example, I can make coffee at home instead of going to Starbucks or plan a date at home instead of eating at a fancy restaurant. I have noticed I can easily find a few hundred dollars’ worth of savings this way.
Making coffee at home rather than picking up a cup of Starbucks can make a big difference. Buying coffee is roughly five/six dollars a day which amounts to $2,000 a year. Instead of spending that cash each morning, brew up a cup of coffee at home and transfer that money into your savings. Combined with compound interest, that $2,000 per year can quickly build up.