Millennials already stretched finances could face a new stress: slower growth of the U.S. economy.Compared with their parents, todays younger workers may need to save more of their income for retirement, according to a new NerdWallet report.
A number of analysts predict that the continuing pattern of slower growth that has taken hold since the Great Recession could cause stock market returns to fall from 7%, the annual average since about 1950, to a possible 5% in the decades to come. And that could hurt investors saving for retirement.
The new goal for retirement
The difference of two percentage points in broad stock market returns has big implications for younger adults who are just starting to save for retirement and also for those who’ve been investing for about a decade. NerdWallets analysis shows that millennials, who could earn a 5% return over the bulk of their investing lifetimes, may be required to save 22% of their annual income to make up the gap. Many retirement experts currently recommend saving 15% of annual income.
The era of supernormal returns is over, says Martin Small, the head of U.S. iShares for BlackRock, the world’s largest asset manager. Over the longer term, younger investors should expect yields and equity market returns to be low.
To help a millennial investor prepare for the future, NerdWallet analyzed the saving needs of a 25-year-old earning $40,000, the median salary for ages 25-29, according to the U.S. Census Bureaus 2015 Current Population Survey.
Based on the 7% average in stock market returns each year since 1950, a 25-year-old earning $40,000 can meet a common retirement goal of replacing 80% of his or her income by age 67 by saving 13% of annual income.
But if average annual stock market returns fall to 5%, NerdWallets analysis shows a 25-year-old will have to set aside 22% of annual income to save the same amount. Thats an increase of $3,400 this year equivalent to over three months of rent, based on the median monthly rent of $937 for 25- to 29-year-old households.
How millennials can start preparing now
Start saving: In addition to saving more income, lower investment returns mean millennials may need to start contributing earlier to a retirement savings account than their parents did, or plan for longer careers. Use a retirement calculator to assess progress toward retirement goals and identify potential gaps.
Take advantage of tax benefits and employer matches: Estimates show a quarter of employees arent contributing enough to get the full 401(k) match. That match is free money that gets you closer to your savings goals.Those who dont have a 401(k) can get a tax deduction by making contributions to a traditional IRA.
Dont stash your retirement money in a savings account: Focus first on earning your employers 401(k) match and setting aside at least $500 in case you need quick cash. Then, consider opening a Roth IRA account and start funneling savings into that. By investing in low-cost vehicles like exchange-traded funds and index mutual funds tied to the overall stock market, like the S&P 500 Index, your money will go to work for you over the decades rather than collecting the lowinterest rates of most savings accounts.
Jonathan Todd is a data analyst at NerdWallet, a personal finance website: Email: firstname.lastname@example.org. Twitter: @yontodd.
A saving strategy that doesnt feature a savings account might seem counterintuitive, like trying to get in shape without a gym membership. But you dont need elaborate equipment to break a sweat, and you dont have to depend on your savings account to boostyour nest egg.
With low interestrates, you wont see significantgrowth in your account, sothe following strategies could prove to be much more effective.
The benefits of certificates of depositmay not be obvious right away. To some people, CDsmight even sound like a borderline scam:Youre telling me my money islocked away for up to five years, and if I want to withdraw it early, Ill be charged a fee?
That is correct. But look at it this way: If you want to save $1,000 for an island getaway, its best to shove that money to the side and forget about it. If you keep that cash in a standard savings account, you might dip into it when your checking account is running low. Put it in a CD, and it will be there when you need it.
Plus, long-term certificates those with term lengths between three and five years typically have better annual percentage yields than even the best savings accounts. And short-term CDs will still help you achieve your more immediate savings goals, such asa vacation, even thoughtheir interest rates arent quite as strong.
Check out NerdWallets best CD rates tool to see whats available.
Say you saved up for that vacation and are sunning yourself on some far-off beach.
Life is good: Your relaxation levels have reached a new peak, and youre close to becoming the human embodiment of an Enya song.
But youve also let your guard down, which can leave you prone to impulse purchases. New rainstick? Sure. Wildly overpriced banana boat ride? Why not?
Thats when a prepaid debit card can come in handy. This payment method doubles as a budgeting tool. Unlike with other plastic, you can limit your spending to only the cash loaded onto your prepaid card, so you wont have to raidyour savings to cover next months credit card bill.
The best prepaid debit cards have no monthly fees, and it doesnt cost much to load money onto them.
Online banking has made it easier than ever to unleash your inner control freak, which can be helpfulwhen it comes to saving money.
At most banks, customers can choose to receive texts or emails when their checking account balance goes below a certain amount. Thats primarily toprotect you from overdraft fees, but can also help you monitor and rein in your spending, and, in turn, keep yoursavings intact.
You can set this limit as high as youdlike and change it over time. Like a prepaid debit card, alerts also can help you control your spending.
At $12 a month, it can be tempting to write off a banks maintenance fee as a minor inconvenience. But if you were to putthat cash in aretirement accountand give itsome time to grow, itwouldnt feel so insignificant.
Say that$12 went intoyour 401(k) plan each month and stayed there for 30 years. Assuming a 6.5% rate of return, youd be left with an additional$13,000 not enough to retire, but a solid addition to your post-work fund, and a good incentive to switch over toa no-fee savings account.
Next, re-evaluate your budget. Make cuts where possible. That doesnt mean resorting to DIY haircuts anda diet of SpaghettiOs and Pop-Tarts.
Using the extra dough to increaseyour monthly retirement contributions by a few percentage points will allow you to reap a nice reward down the road, thanks tocompound interest.
Alternatively, you could use that extra cash to pay down high-interest debt. Any kind of adjustment to your spending and savings habits, no matter how small, can make a big difference over time.
Tony Armstrong is a staff writer at NerdWallet, a personal finance website. Email: email@example.com. Twitter: @tonystrongarm.
This article originally published at NerdWallet here