This post was originally published on our previous blog website, www.FinancialClarityBlog.com on January 3rd, 2017 and has been revised and updated. It was the first official blog post I ever wrote! Felt like it would be a good one to bring back and revisit to help motivate people to achieve their savings goals.
As we progress through the fourth quarter of 2019 and approach the end of the year, it is time to start thinking about possible New Year’s resolutions. As we all know from experience, coming up with a New Year’s resolution is the easy part. The challenge comes from actually implementing and sticking with our goals. This is why every year in January, gym membership rates and attendance skyrockets – you practically have to elbow people out of the way to get in a run on a treadmill. By March, however, the masses have lost their motivation, allowing you to stroll into the gym and have your pick of exercise equipment for the day.
Financial goals are no different from exercise goals. People have the best intentions of improving their financial habits, but when it comes time to actually make a change, it becomes difficult to pull the trigger. Here is one idea that everyone can implement with ease: Save More Tomorrow.
The term Save More Tomorrow was originally coined (I believe) by Richard Thaler and Shlomo Benartzi in their research paper written at the University of Chicago and published in the Journal of Political Economy in 2004. If you are not into reading research papers, Thaler’s book, Misbehaving, discusses the concept in one of his chapters. The book is a good read if you are eager to learn more about behavioral finance.
The Save More Tomorrow Concept
The Save More Tomorrow concept is simple: gradually increase employees’ retirement plan contributions automatically every year. The assumption (correctly so) is that people are lazy and will take the path of least resistance. Enrollment in company retirement plans is significantly greater for companies that have automatic enrollment, versus companies that require employees to proactively enroll. Employees also save significantly more when, in addition to automatic enrollment, their contribution rate automatically increases as well. Using the same logic that people are lazy and won’t proactively enroll or increase their retirement savings contributions, people are equally lazy and generally don’t opt out of contributing to a retirement plan. And when their contributions increase by small amounts each year, they don’t even notice.
How You Can Implement The Strategy Yourself
How can you use this strategy to your advantage? You may already be enrolled in a retirement plan at work that has adopted the above strategy. Excellent. If you are not sure, ask HR or log into your account online to see if your contribution rate is set to increase in the future. While you are in there, go ahead and increase your contribution by a small amount (one or two percent of your salary). You will feel good about yourself after you do it and you won’t even notice the difference on your next paycheck.
If your retirement contribution is not set to automatically increase every year, log into your account and bump up your contribution rate by one or two percent. After doing that, see if there is an option that enables you to enroll in the automatic contribution increase feature. Often it is simply a box to check on the website and hit confirm. Then you are all set! Your contribution will automatically increase every year.
What If Automatic Escalation Isn’t an Option in My Retirement Account?
Some of you may not be so lucky to have a retirement plan at work that allows you to automatically increase your retirement contributions every year (I encourage you to raise this concern with your employer and try to get them to implement automatic escalation). In this case, you need to punish yourself and spend five minutes of your time on your retirement plan website once or twice per year. It’s like going to the dentist, but you can do it from home in your pajamas. Set a recurring reminder on your phone, or on your calendar to log into your retirement website every six or twelve months. Find the contribution elections link to change your contributions. Increase your contribution rate by one or two percent. Do this every six or twelve months and every time you get a pay raise. Before you know it, you will be maxing out your retirement plan contributions at work (current employee contribution limit of $19,000 for 2019; $25,000 if age 50+).
What If I’m Already Maxing Out My Workplace Retirement Account?
If you are already maxing out your retirement plan at work, or are looking to invest elsewhere, you can implement the same strategy with other accounts. Many investment companies have an option to automatically increase your investment contributions annually or at other desired intervals. If you have your financial advisor manage your investment accounts for you, ask him or her to automatically bump up your contributions every so often by a certain amount.
Show Me An Example of This
Even small amounts increased gradually add up over time. Assuming your income rises over time to keep pace with inflation, the small increases will be hardly noticeable. For example, I recently opened a college savings account for my newborn son and started contributing $500 per month to the account. With college tuition costs rising twice as fast as inflation, it will cost approximately $250,000 to attend a four-year state college by the time my son graduates high school and about $600,000 to attend an out of state or private university. I’m only paying for four years – if he takes longer than that, he’s on his own.
The plan is to automatically increase that monthly contribution by $100 every January. See the below table for an example of how the investment will look after 18 years.
As you can see, by year six I am investing $1,000 per month. By year 15 the amount is $1,900 per month. If the investments within the account grow by a hypothetical rate of 5% per year, the balance at the end of December in his senior year of high school will be just over $425,000. If my investment account can average a 7% rate of return per year, I will have just over $500,000 when high school is over.
The hardest part is getting started. Start by investing small amounts and slightly increase the amount you are investing every 6-12 months. Maybe every time you get a pay raise or every year on your birthday you bump up the amount you are investing by a small amount. Before you know it you will be well on your way to reaching your investing goals!