Today, successfully preparing for retirement requires you to be a smart saver.
Traditionally, the middle class has used Social Security, pensions and home equity to build retirement savings, but these methods seem to be failing. It’s time for you to take a new approach to building a nest egg.
Economists predict Social Security trust-fund reserves will be exhausted in a little more than 20 years. Social Security was designed to provide a basic level of income for workers and their families, after workers reached “old age,” became disabled or died.
At one time, pensions promised a monthly benefit based on a formula that factored in earnings, length of service and age rather than individual contribution and return on investment.
Exemplified by government pensions, these defined-benefit plans have been replaced by defined-contribution plans. These pensions shift investment risk and responsibility away from the company to the employee.
Paying off a home mortgage on a 30-year term automatically sets up a wealth-building program. Homeowners who stick to the plan steadily build home equity. Unfortunately, the home-loan refinancing industry reminds us how easy it is to reduce our mortgage payment and use our equity to finance our next major purchase.
And, even when homeowners promise to pay extra to pay down their mortgages, they often fail. Behavioral economists have proved that we are more likely to spend the monthly savings from a mortgage refinance on something else and unlikely to deviate from the minimum monthly mortgage payment.
The low-willpower solution
These traditional methods worked well because they didn’t require much willpower. Workers had money withdrawn from paychecks for Social Security and pensions, while a mortgage created a consistent and growing contribution toward home equity.
The keys to savings success are a low-willpower requirement and increasing contributions.
To head down the path toward building a better nest egg, first create a realistic budget, pay off non-mortgage debt and build a three- to six-month emergency fund.
Now, with an investment adviser, establish an automated savings plan equal to at least 3 percent of your income. Automated withdrawals eliminate the need for willpower.
The good news: Once you’ve started investing, you’re unlikely to stop. The bad news: Without a push, you’re not likely to increase your savings rate.
To stay on track, schedule a meeting with your investment adviser each January and when daylight saving time change in the fall and spring. Select one of these three meetings as your savings-increase date. Increase your rate by 2 percent annually until you reach a 15 percent savings rate.
Lastly, commit to adding half of any pay increase to your savings plan and try to pay off your mortgage in 15 years.
Once your plan is in motion, it’s likely to gain momentum.
email@example.com. Durango resident and personal finance coach Matt Kelly owns Momentum: Personal Finance. www.personalfinancecoaching.com.