Saving for the Future? 1 Percent Can Mean a Lot
April 13, 2015 | Your Finances
When it comes to saving for the future, it’s often the little things that make a difference. Even a 1 or 2 percent change in the amount you save and/or spend can have a profound impact on your ability to fund the lifestyle you want for the future. To understand why, consider the following example.
Let’s say you currently earn $50,000 a year and contribute 5 percent of your salary each month to your 401(k) at work. If you continue to save at this rate, you’d have $377,408 in your account by the time you retired 35 years from now, assuming you earned a 7 percent average annual return.
Now let’s say you increase your contributions just 1 percent. With just a small boost in the amount you save each month, you’d be able to add at least $75,482 more to your nest egg over 35 years than if you had maintained your flat 5 percent contribution.1
How can just 1 percent make such a difference? The power of tax-deferred compounding is that it enables you to earn interest on your contributions, which are reinvested to generate earnings of their own. And because your money isn’t taxed until you withdraw it, typically when you’re no longer working, your money can compound even more quickly than if you saved it in an account that was taxed annually.
Want to grow your 401(k) even more? Consider automatically increasing the percentage you contribute whenever you get a raise at work.
Small Steps, Big Results
What if you don’t have the money to increase your contribution to your 401(k)? As with many people today, saving for the future may take a back seat to other more immediate demands on your money. Often a closer look at your monthly budget can spark ideas for small but important changes that can help you cut spending a little and boost saving a lot. Here are three ideas to consider.
1. Spend less on little things. One of the easiest ways to free up money for savings is to reduce your spending even just a little bit. Take your morning coffee, for example. If you’re like many people, you probably stop on the way to work to grab a cup. Over time, the cost of that morning coffee adds up: According to E-Imports.com, the average cost of a brewed coffee is currently $2.38, which means your morning coffee could cost you nearly $600 a year.2
What if you decided to get your coffee from your office kitchen instead, or skip it altogether? While the $2.38 you’d save each day may not seem like a lot, it actually could add up over time. In fact, if you invested $600 ($50 per month) every year for 30 years and earned a 7 percent average annual return, you’d have an extra $61,354 for your future.
2. Reduce your credit card interest rate. The interest on credit card debt can add up, especially if you carry a balance from month to month. If you’re in the market for a new credit card, carefully compare the annual percentage rate (APR) of any new credit card you’re considering with other available options. Selecting a card with an APR that is even just a percent or two lower can cut your interest costs, giving you more money to save, rather than spend, each month. If you have an existing card that you carry a balance on, and your financial situation has improved since you got it, call your bank and see if you can negotiate a better deal. A September 2014 survey by CreditCards.com found that two out of three cardholders who asked for a lower rate got it.
3. Shop around for a mortgage. Buying a home? Make sure you compare lenders to lock in the best mortgage rate and terms you can get. The same is true if you’re looking to refinance an existing mortgage. Because a mortgage involves repaying a lot of money over a long period of time, even a slight reduction in the interest rate you pay can make a significant difference in your monthly mortgage payment and in the total cost of your loan over time.
To understand how much, consider this example. Let’s say you need a $200,000 loan to buy a new house. Your realtor points you to a local bank that is featuring a 4.50 percent 30-year fixed mortgage. Your monthly payment would be $1,013. You decide to shop around and make a call to your local mortgage broker. She can get you a 30-year fixed mortgage with the same terms as your local bank but with a 3.50 percent interest rate. That 1 percent difference in interest rates will cut your monthly mortgage payment by $115 and save you about $41,501 over the 30-year life of the loan. That $115 month could help boost your savings.
Small Changes Can Yield Big Results
One percent may not seem like a lot, but over the long term it can really add up. As you take steps to boost your savings for the future, look for little ways to save more each month and reduce your spending. Small changes can translate into big savings, and that can make all the difference when you’re investing for something as important as your future.
- Additional information: Whitepaper: Changing jobs? Don't overlook these top 5 considerations that can have a big impact on your financial picture.
1This hypothetical example is for illustrative purposes only. It assumes you earn $50,000 a year and your account earns a 7 percent average annual return. This example does not take into account any raises you may receive; it also does not reflect the impact of taxes, which would reduce any withdrawals you may take. This example is for illustrative purposes only and is not intended to reflect any specific investment. Past performance does not guarantee future results, and returns will vary.
2This example assumes you work 250 days a year and purchase coffee each morning you work.