By Katie Brockman, The Motley Fool
There are plenty of scary statistics about how the average American isn't saving nearly enough for retirement. One in five American adults has nothing at all saved, according to Northwestern Mutual, and Gallup found only 38% of non-retired investors have a written financial plan.
And it's not just saving for retirement where people are struggling financially. In fact, nearly a quarter of American adults over age 62 are financially insecure -- meaning they have trouble paying basic expenses, obtaining credit, and saving enough to cover an unexpected cost of $2,000 or more -- according to a recent study from the Bureau of Consumer Financial Protection.
When you're struggling to make ends meet, it may feel impossible to reach larger financial goals like saving enough to be able to retire. But that doesn't necessarily mean retirement is out of reach. In fact, it may be easier than you think to get your finances on track.
The good news is that the more you know about how to properly manage your finances, the better off you're likely to be, according to the Bureau. Researchers found that people with higher levels of financial knowledge, and those who routinely save money and engage in healthy money management practices had higher levels of financial well-being than those who didn't.
In other words, the more educated you are about your finances, the easier it will be to manage them wisely so you can accomplish your goals. To do that, there are a few places to start:
1. Create (and maintain) a budget
The first step to properly managing your money is knowing where your money is going. Figure out what exactly you're spending each month, then break those expenses down into categories of necessary and unnecessary. You may find that you're spending more on unnecessary expenses than you initially thought, and trimming down some of those costs can make it easier to reallocate that money toward your financial goals (such as saving for retirement, paying down high-interest debt, establishing a robust emergency fund.)
But budgeting isn't a set-it-and-forget-it task. Once you make an initial budget, the next step is to update it regularly and improve on money management. Rather than simply tracking expenses, set monthly spending limits -- and stick to them. If you know you're only going to be spending a certain amount each month, you'll also know how much you'll be able to put aside toward your goals.
2. Know your retirement number
Retirement planning can seem like a monumental task, but sometimes the hardest part is just getting started. The first step in the journey of retirement saving is figuring out your retirement number -- or the total amount you need saved by the time you retire.
There's no foolproof way of knowing exactly how much you'll need to pay for your all your living expenses in retirement. There are many variables involved, and no matter how much you plan, unexpected expenses will inevitably arise, forcing you to change course. However, that doesn't mean you should throw your plan out the window and wing it instead.
To determine your retirement number, first estimate how much you'll need each year to cover all your expenses in retirement, which will likely be similar to what you're spending now, but might differ depending on the lifestyle you're planning. A globe-trotting retirement will look quite different than simply tinkering around the house in your old age. This is also where a budget will come in handy, because you'll already have a good idea of what you're currently spending.
Next, consider other sources of income, including Social Security benefits, as well as any annuities or pensions. While you won't be able to rely solely on Social Security benefits, they can cushion your income so that you don't need to save as much on your own. For an estimate of how much you can expect to receive in benefits, check out the Social Security Administration's online calculator. Once you know how much you're on track to receive from the program, subtract the amount you'll be receiving in benefits (and other sources of income) from the total amount you'll need each year in retirement expenses, and the difference is how much money you'll need to pull from your own savings -- each year.
Finally, multiply that number by 25 to find a ballpark goal for your entire retirement. This math is based on the 4% rule, which advises that you withdraw 4% of your retirement fund during the first year of retirement, then adjust that number upward each year after to account for inflation. That total will be your retirement number, or the big saving goal you should be aiming for to provide yourself with the monthly income you need in retirement.
3. Start with bite-sized goals
Having an enormous goal in mind can make it feel so far out of reach. If you determined your retirement number is $500,000 and you're barely scraping by as is, it may seem easier to give up trying to reach that lofty goal. However, breaking your goal down into bite-sized chunks will make it seem more attainable.
For example, say you're 40 years old and you want to have $500,000 saved by the time you turn 70. If you don't currently have anything saved for retirement, you'll need to save roughly $450 per month (assuming you earn a 7% annual rate of return on your investments) to reach that goal.
If that in itself seems unmanageable, go back to your budget and see where you can make cuts in your spending or boost your income. If you can only manage to save $100 per month right now, that's better than saving nothing, as time and compounding will turn that initial sum into a much bigger amount once invested.
Start with a smaller, more attainable goal, then work your way up to the bigger milestones. The earlier you start saving, the more time your money has to grow, thanks to the power of compound interest. The power of growth over time means it's better to save a little now than to put it off until later on when you have more money to save. Make it a habit today to pay yourself first, so you don't spend your savings before it makes it into the bank.
No matter how much money you have or how old you are, saving is never easy. But it's crucial if you want to eventually retire and not have to spend your golden years constantly stressed. Although saving enough is a challenge, simply learning as much as you can about your finances and how to manage your money in a healthy way will help set you up for long-term success.
