Recently I made a spreadsheet to see how the percentage of the income we save, affects our wealth when we retire. Specifically, I wanted to see the magnitude of difference that small increases in savings can have at retirement. I assumed two fictional employees, Greg Green, and Bob Blue, both making $35,000 a year and starting out by contributing 5% of their income towards retirement. Then I assumed that their paycheck grows identically at 3% a year. For simplicity sake, I ignored matching contributions and potential taxes on their income and assumed that their take-home pay is equal to what they were paid minus what they contributed to retirement. I also assumed that their retirement accounts would generate the same long-run market return of 7% annually.
Mr. Blue steadily contributed 5% of his paycheck to retirement. Mr. Green starts out by contributing 5%, but instead of keeping it there, he bumped up his contributions by a quarter of a percent every year. So, in year 1 Mr. Green contributed 5%, in year 2 he contributed 5.25%, in year 3 he contributed 5.5%, and so on.
If we look at take-home pay for the respective employees this difference will start to become apparent. So it’s clear that Mr. Blue brought home more money to spend on fun new things, but it’s not that much more. In an average year, over the last 20 years, Blue brought home $1300 a year more. To put it into perspective, let’s take a look at how much less in contributions Blue has saved for retirement over that time period.
Wow, now that’s quite a difference. In fact, if you sum those yearly contributions, Mr. Green will have contributed more than $24,000 more than Mr. Blue over the course of his working career. But that’s not where our analysis ends. Let’s see how much more in retirement savings Mr. Green ended up with after 20 years and account for market returns.
Ok, now you can clearly see a massive difference. Green has effectively doubled his extra savings ending up with nearly $56,000 more in wealth than Blue. And what sweet new toys do you imagine Mr. Blue used his average $1300 extra dollars a year on every year? My guess is things that are not worth anywhere near $1300 now. Smart move, Mr. Green, smart move.
The takeaway here is that foregoing a few extra dollars during your working career can buy you more time in retirement. You can use that time to pursue any number of fun and fulfilling activities. The more money (and by extension “things”) you have will not make you happier ad infinitum, but time is the ultimate commodity. And so if you’re holding off on saving for retirement just to increase your disposable income, perhaps you should reconsider.