I am currently reading “Atomic Habits” by James Clear. He writes compellingly about creating big improvements in nearly any area of our lives by making small steady changes over time.
I’m not quite done with the book so it is not this month’s book giveaway – tune in next month to win a free copy!
This formula certainly works for saving money. Many 401k plans have encouraged the idea by offering an “auto escalation” feature.
With auto escalation the percentage of salary you contribute goes up, typically by 1% each year. When you sign up for this feature this happens automatically which is a great way to save!
To see the impact of escalating your savings percentage let’s take a look at two young women at the start of their careers: Susan and Sally.
Susan and Sally are both 25 years old and they both have jobs paying $45,000/year.
Susan decides to contribute 5% of her salary to her 401k plan.
Sally also decides to contribute 5% of her salary to her 401k plan.
They each contribute $2,250.
After one year, both Susan and Sally get a 3% raise. Now they are each making $46,350.
Susan continues with 5% salary contribution. Sally increases hers to 6%.
Susan contributes $2,317 and Sally contributes $2,781.
After another year, both Susan and Sally again get a 3% raise. So now they are each making $47,740.
Again, Susan continues with 5% salary contribution. Sally increases hers to 7%.
Susan contributes $2,387 and Sally contributes $3,341.
This repeats for a total of 32 years: a 3% raise every year, Susan continuing with 5% contribution every year and Sally escalating by 1% each year.
Then when they are 57 (and believe me, this goes by in a flash!), their salary is $115,878.
That year Susan contributes 5% or $5,793 and Sally has escalated up to 37% of salary or $42,875!
Now let’s assume that those contributions over the last 32 years have earned 5% a year.
How much do Susan and Sally have?
Sally has a little over a million dollars. Susan has about a quarter of that amount.
Of course Your Mileage May Vary – historically portfolio returns over this length of time have been better than this!
The flip side to saving is of course spending.
Because Sally is saving such a large percentage of income, she is spending much less than Susan.Increasing your savings percentage helps slow the increased spending of “lifestyle creep”.
Susan is spending ≈$110K a year and Sally is spending ≈$73K a year.
Sally has a larger nest egg and a smaller lifestyle!
Saving 37% of your income may seem like an impossible achievement. But Sally didn’t get there overnight-it took 32 years of steady annual 1% increases.
I realize not everyone’s life proceeds in a linear fashion like this. You might drop out of the work force for a time to care for family members. You might not get a raise every year. On the other hand, you might get a few promotions along the line and get bigger increases!
Save, Invest, Repeat. Start early, increase often.
*all dollar amounts are rounded
*spending includes taxes