The Multiplicative Effects of Saving

  • Finance Friday

It’s Time to Start Your Savings Plan.  Here’s Why:

There’s a multiplicative effect to saving money that everyone needs to know.  The three main factors at play are simple enough:

  1. Every dollar saved is money that will be available to use in the future.
  2. The same money can be invested to further grow over time.
  3. In order to increase savings, expenses must also be reduced.  Lower expenses makes it easier to save enough money for retirement since you don’t need to save as much to maintain the same lifestyle you had before retirement.

Let’s Take a Look at an Example to See How a Higher Savings Rate (Plus Lower Expenses) Puts All Three of These Factors to Work for You:

Assumptions:

  • First Year Earnings = $100,000 per year
  • Inflation = 3% per year
  • Annual Investment Returns = 6% per year

Example 1: Saving 5% Per Year

Effects of Savings 5% Per Year

Notice that at the end of ten years our investor has failed to save even a single year worth of her annual expenses.  This is an obvious problem for someone who’s trying to build a nest egg large enough to retire on.

Example 2: Saving 10% Per Year

Effects of Saving 10% Per Year

In order to save 10% per year, our investor had to reduce her annual expenses accordingly.  That can be tough to do.  It definitely requires some sacrifices, but the results speak for themselves.  By increasing savings from 5% to 10% our investor was able to save one full year worth of expenses in approximately 7.5 years.  That’s not too bad!

Example 3: Saving 15% Per Year

Effects of Saving 15% Per Year

As you can see, things start to look very promising for our investor when she’s saving 15% of her income.  In order to make room for her extra savings she needed to reduce her expenses to $85,000 in the first year, which probably wasn’t easy.  But within ten years she was able to save over two years worth of her expenses.  This is a very solid foundation to build a long-term investment portfolio off of.

Example 4: Saving 20% Per Year

Effects of Saving 20% Per Year

OK, you may think we’re over doing it now.  Yes, 20% is a large portion of your income to save, but check out the results!  In order to save such a large portion of her income, our investor needed to drastically adjust her lifestyle, but that makes it even easier to save each year worth of expenses for retirement.  At this rate, it only took her 3.5 years to save one full year worth of expenses.  That’s incredible!  Plus, after ten years, she’s got over three full years saved.  Compare that to our 5% saver and it’s an incredible improvement.

How to Start

You can either implement your new savings plan quickly or slowly.  Whichever you choose, just make sure you start!

Friends of mine just sold their house and moved into their fifth wheel camper in order to reduce their annual expenses and make saving money a priority.  While that might seem drastic to some, for them it was the perfect way to jump start their savings plan.  Others may need to start more slowly, and that’s OK too.  The most important thing to do is start.  The second most important thing to do is stick with it!  No one is going to save for your retirement for you.  So the earlier you start the easier it is.

Need Help?

If you’re unsure where to cut expenses or how you can save on taxes using the proper retirement accounts, set up a financial review with one of our advisors.  Our cost effective review sessions are the perfect solution to help you get your new savings plan off the ground.

*Example Limitations – This is a simplified example of our investor’s finances.  Please note that pre-retirement expenses are unlikely to match post-retirement expenses.  While medical costs and travel expenses (among other things) usually increase in retirement for most people, taxes, debt payments and other items usually decrease.

2017-11-10T09:26:48+00:00

About the Author:

Tim Plachta, CFP® owns and operates Reliant Wealth Management and Reliant Consulting Partners.  He works primarily with small business owners to help them increase profit, reduce their workload (so they can relax more), and invest enough of their earnings to achieve financial independence.