Updated on 12.03.14

The Gradual Savings Strategy

Trent Hamm

When the time arrives to sign up for a retirement plan at work or open a Roth IRA, people are pulled in two different directions.

On the one hand, it’s very obvious that in the long term, saving for retirement is far superior to not saving for retirement. Retirement planning offers the ability to retire with some degree of comfort and often allows the saver to retire years earlier than the person who does not save.

Yet, on the other hand, it appears very painful in the short term. Like it or not, saving for retirement is going to cut into your paycheck, and if you’re already struggling to make ends meet, that is an incredibly bitter pill to swallow.

Quite often, when people are faced with this dilemma, they convince themselves that retirement is so far off that they can wait a little while to start saving. I’ll start saving in a few years when things are in better shape, they’ll say to themselves.

The problem is that the “better shape in a few years” that they envision rarely ever comes and, before they know it, retirement is starting to loom closer and closer and closer and they have nothing.

I’ve watched too many people in my own life go through this. I’ve also read far too many emails from readers going through this. It’s painful and scary.

And it’s unnecessary.

First of all, the impact on your current paycheck from retirement savings isn’t as big as you think it’s going to be. If you’re putting your money into a 401(k) (or something similar) through your job, every dollar you put in is going to result in less than a dollar disappearing from your take-home pay. It depends on a lot of factors, but a dollar saved in a pre-tax retirement account will result in somewhere between $0.50 and $0.90 taken out of your actual paycheck. The impact simply isn’t as big as what you might imagine.

Second, saving anything is better than saving nothing. If you’re paid weekly and you put $1 – just $1 – per paycheck into a 401(k) starting at age 20 and invest it reasonably aggressively in stocks, you’ll have $23,000 saved up at age 70. Make it $10 per paycheck, and you’ll have $230,000 saved up at age 70. You’ll be able to withdraw about $10,000 a year (post-tax) for the rest of your life from that kind of savings.

Third, a slightly smaller paycheck is going to have zero impact on your day to day life. If your paycheck is suddenly a few dollars less, you’re not really going to notice it at all.

Of course, there is a level where you will notice it. If your paycheck immediately drops by 10%, you’re certainly going to notice that.

The trick is finding that level – and it’s a different level for everyone – where you don’t really notice the change at all, yet you’re still saving up for retirement. If you can do that – and do it as early in your financial life as possible – you’ll be well on your way to retirement savings without any real negative impact on your life.

So, how do you do that? I recommend using a trick that I call “the gradual savings strategy.”

The Gradual Savings Strategy and You

The strategy is a simple one. Tomorrow – or today, if you’re reading this early in the day – go into your human resources office at work and sign up for retirement, but put aside the lowest amount you possibly can. Most of the time, this will be 1% of your pay or something tiny like that.

To put that in perspective, let’s say that your take-home pay is $500 a week. Putting 1% of your pay into your new 401(k) account will have an impact of reducing your paycheck by somewhere between $2.50 and $4.50. You can’t even stop at Starbucks for that little.

(A quick aside: if you don’t know what to invest your money in when signing up for your 401(k), just ask about a target retirement fund and choose that one. It’s almost always a very solid choice.)

So, you’ve signed up to put aside 1% of your salary for retirement. You’re now actually taking action for retirement when you weren’t doing so before. Good! You’re heading in the right direction.

The only downside is that your paycheck just went from $500 a week to $496 a week. To be honest, you’re not even going to notice it, but if you doubt that, just sit tight.

At this rate, assuming you started at age 20, you’ll have somewhere around $80,000 saved up for retirement by the time you reach age 70.

Leave that contribution alone for a month or two. Don’t change anything else. See if you even notice the difference. I’m pretty confident that you won’t notice it, actually.

So, two months have gone by and you’re not even noticing that 1%. Now, go in there and change the 1% contribution to 2%. Again, with a $500 paycheck, it’s going to cause your pay to go down by somewhere between $5 and $9. Again, you’re most likely not even going to notice it.

At this rate, assuming again that you start at age 20, you’ll have somewhere around $160,000 saved up for retirement at age 70.

Again, wait two months. Do you notice anything now? Is that 2% an unwelcome burden on your finances? Likely, you’ll still notice nothing at all.

If you still notice nothing after two months, bump it up to 3%. Your $500 paycheck goes down by somewhere between $7.50 and $13.50, and you’ll have somewhere around $240,000 saved up at age 70 if you start at age 20.

Are you starting to see the pattern here? Again, you just sit tight for a month or two and see if you notice any negative impact on your life. If you do, leave the contribution alone or even drop it down by a percentage point. If you don’t – and at 3% you probably won’t even notice it and if you do it won’t be painful – then go back in after a month or so and bump it up another percentage point.

Keep doing this until you find the threshold that actually causes any sort of real negative impact on your day-to-day life. That amount really depends on how precarious your finances are and how much self-control you have over your spending.

The impact will mostly appear in the form of cutting back on little unnoticed things like buying sodas at the gas station. You might check your checking account balance one day and decide not to go out and instead have a movie night at home.

With each little bump upwards, you’ll start to notice the impact a little more. Maybe it’ll be enough for you to finally see the impact. Maybe you’ll actually become uncomfortable. That’s a sign to stop where you’re at. Likely, though, you won’t notice it at all, which is a sign to contribute a little more.

If you manage to get your contributions up into the 15% range without noticing it, congratulations. It’s very likely that you’re now contributing enough to retirement to not have to worry very much. You’ll likely be able to walk away at age 65 or perhaps even earlier. Just stick with that 15%.

Most people will find a point below the 15% threshold where it begins to be uncomfortable for them. When you hit that point, stop. Don’t contribute any more. If it’s uncomfortable, drop it back by a single percentage point and leave it where it is.

The big advantage of gradual savings is that it enables you to save some for retirement without having it negatively impact your day-to-day life right now in any serious fashion. If it reaches a point where you are feeling a pinch, then don’t contribute more. It’s about finding your comfort zone.

For some, that comfort zone might just have enough breathing room to hit their retirement goals and they just don’t realize it yet. Fear is the only thing holding them back.

For others, the comfort zone might be a little lower. In that case, at least they’re saving something for retirement and that’s better than nothing.

Remember, the goal of the “gradual savings strategy” is to nudge you slowly into contributing something. Many people never contribute anything at all and find themselves in a serious pickle when they get older. If you start contributing as soon as possible, you avoid falling into that trap.

The “gradual savings strategy” isn’t going to solve all of your problems. It likely won’t help you find enough savings to be able to retire early or anything like that. What it will do is help you find balance and help you get started on your retirement savings if you haven’t done so before.

If you’re afraid that saving for retirement is going to devastate your paycheck and that fear has kept you from saving even though you know that it’s the smart thing to do for the long term, give the gradual savings strategy a whirl. I’m almost certain you’ll be glad that you did it.

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