Take More Risk or Save More for Retirement?

The chart below from Craig Israleson’s article, Best Way to Increase Retirement Savings, clearly illustrates the value of beginning to save for retirement early in your career.  With a 6% average annual return, if you save 6% of your salary starting at age 25, you have a portfolio worth $528,007 at age 65. Delay saving for retirement until age 45, and that account accumulates just $194.606.  (Note this analysis assumes a salary of $35,000 at age 25 and a 3% annual increase in pay.)

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Significantly, Israleson’s detailed analysis also measures the impact of increasing your savings rate versus changes in the portfolio return. And he discovers that while, for younger clients, the portfolio’s rate of return has more impact on the ultimate account value than the annual savings rate, the opposite is true for older clients. That is, if you wait to save for retirement until age 45 your portfolio can benefit more from increasing your savings rate to 10% than from attempting to increase your portfolio’s rate of return to 10%.

That finding makes a solid argument for those getting a late start on retirement savings not to take on additional portfolio risk to try and boost returns. Moreover, it’s another reason for older workers to take advantage of catch-up contributions to their 401(k), capped at $5,500 for 2013.

Remember, to take advantage of the catch-up provision, you first have to contribute up to the regular 401(k) limit–$17,500 for 2013. Almost all employers allow catch-up contributions in their 401(k) plans — and you are eligible to make them in the year you turn 50.

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