More than half of U.S. adults saving for retirement are making one big mistake: They are using a regular savings account.
Only 52% of Americans are putting aside money for retirement in the first place, according to a 2019 survey of 2,200 adults from the Certified Financial Planner Board of Standards, Inc., in collaboration with the global research firm Morning Consult. The survey asked those respondents to point to the kinds of accounts they are using to get to that goal. The top choice, selected by 62% of those prepping for retirement, is a 401(k).
But the No. 2 answer, chosen by 53% of those preparing for retirement, was a savings account. It's unclear how many respondents are using a savings account as a substantial part of their retirement plan, or instead of a 401(k) or IRA. All the same, focusing on saving rather than investing could cost them, experts say.
Savers "don't realize it is hurting them in the long run because they're not even beating inflation," says Carolyn McClanahan, a certified financial planner with Life Planning Partners in Jacksonville, Florida.
With an average savings account interest rate of just 0.09%, savers are earning just 90 cents for every $1,000 they put away. Inflation, meanwhile, has recently averaged around 2%. In other words, you could actually lose money over time if even some of your retirement fund is sitting in a basic savings account.
To prepare for retirement effectively, here's how to start thinking like an investor.
If you're using a savings account, you're missing out on the tax benefits of a qualified retirement account like an IRA or a 401(K), as well as a potential employer 401(K) match, which gives you what amounts to free money.
That 401(K) match can help you put towards retirement 10%-15% of what you earn each year, which is the target experts recommend you hit.
Growth is also an important part of meeting your long-term goals. Investing in the market over time can help your money grow, thanks to the phenomenon of compounding, which means you earn interest on your interest as well as on your contributions.
Say you were to save $50 each month starting at the age of 20, assuming a savings interest rate of 1%. You'd save more than $34,000 by age 65, with about $7,000 of that being interest.
Now say you invested that $50, assuming an average annual return of 6%. You'd have roughly $138,000 by the time you're 65, thanks to compounding. That's a difference of more than $100,000.
For some people who are spooked by or distrustful of the market, however, the knowledge that you are likely to come out ahead by investing doesn't matter. This may be due to recency bias, or our tendency to be "shaped mostly by what happened in the recent past," explains McClanahan.
Savers may feel nervous about recent stock market volatility, or they may have watched family members suffer major losses in the last recession, she adds. "People who were hot on the market and then went through this horrible time tend to be uber conservative, and that's going to hurt them in the long run. The best answer is to have a diversified portfolio."
That generally means a mix of low-cost index funds, which track the performance of a particular market index, like the S&P 500. Even though individual stock prices can fluctuate wildly, the broader index tends to go up over time. Index funds allow you to purchase a lot of stocks at once, and make it easier to create a diversified mix that aligns with your tolerance for risk while producing returns that keep you moving toward your goals.
Some vehicles are designed to help you navigate risk. Target date funds, for example, automatically adjust your portfolio for you as you age, so more of your money stays in more conservative investments as you approach retirement.
"What I tell people is that you always need to be invested in an allocation that's appropriate, both for your financial ability to take risks, and your psychological ability to take risk," says McClanahan.
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