We use the Future Value formula to estimate how much savings will grow by the time you retire. I’ve talked about Time in a previous post. I’ve planned an upcoming series of posts discussing Growth Rate. But, contributions is where the rubber meets the road. Contributions are the “fuel” for your financial growth engine. Without them, you’re not going anywhere. The more “fuel” you have the faster you can grow your savings.
It’s difficult for many people to make contributions because they feel they’re paying a lot of their hard-earned money for something when they don’t see the benefit. Contributions aren’t a payment, it’s your money in your account. The benefit is watching how, through compound interest, your contributions will grow a fortune for you.
Once your contributions are invested they immediately go to work. Thanks to the power of compound interest they’ll earn about 5-10 times more money toward your Financial Independence than what you’ll end up saving! In a sense, you’re “employing” your contributions to earn money for you. The more contributions you make, the more workers you have to build your fortune.
How Much Should I Contribute?
The simple answer to that question is, “As much as possible!” However, that’s a little vague. If your employer offers matching money to the contributions you make to your 401(k) you should contribute at least as much as will get every dollar your employer agrees to pay.
If you’re contributing less than what your employer is willing to match you’re leaving money on the table. That’s money your employer agreed to give you as part of your compensation, but you’re letting them keep. The contributions to your 401(k) go to work immediately by capturing the matching funds from your employer. You don’t get this money if you don’t make contributions.
Here’s an example. You make $50,000 a year and your employer matches 50% of the contributions you make to your 401(k) up to 6% of your salary. Your total contributions for the year would be 6% of $50,000 or $3,000. That’s $250 a month. As soon as you make your first $250 contribution, it earns you an additional $125 in matching funds from your employer (subject to vesting). Not counting growth on your investments, your contributions would earn you $1,500 in the first year!
Pay Yourself Before You Pay Others
Ultimately, I think the minimum you should be contributing to your savings is 10% of all that you earn. I believe that God has blessed me with the health, skills, knowledge, intelligence, and opportunity to earn all that I earn. So, I’m happy to give 10% of all that I earn to God through my church as tithing before I pay anything else. I do this to show my gratitude to God, and in doing so I feel that he adds additional blessings that more than compensate for my tithe.
After paying my tithing I paid myself. Most of the time that money came out of my paycheck before I ever saw it. After a few months, I never even noticed. Once I paid myself I lived on what was left.Remember, what you’re “buying” with the 10% that you contribute to your savings is the lifestyle you want to live for the last 20-40 years of your life! Money may not be able to buy happiness, but it can help you avoid misery.
In some circumstances, it’s difficult to begin investing 10% right off the bat. Start with as much as you can afford, and then use these tips to increase your contributions over the next few years.
Supercharging Your Contributions
The more money you contribute, the more that’s available for Time and Growth Rate to take advantage of using the power of compound interest. Bigger contributions produce bigger results. There are 3 ways you can supercharge the contributions to your Financial Independence.
Contribute a Percentage of Your Pay
When you contribute a percentage of your pay toward your Financial Independence instead of a set monthly amount you automatically increase your contributions every time you get a raise! If you’re contributing 10% of your $40,000 a year salary you’re contributing $4,000 a year. When you receive a promotion and your salary jumps to $44,000 a year, your contributions automatically increase from $4,000 a year to $4,400 a year! This happens without any action on your part, and you’re not likely to even notice the increase in your contributions.
It’s easiest to do this when you’re contributing to a 401(k) at work. When you sign up ensure that your contribution is a percentage of your pay instead of a set amount. This is done by default in most cases. This way when your pay increases your contributions increase as well.
Increase The Percentage You Save
Whenever you receive large pay increases plan to increase the percentage of pay you contribute. It’s best if you plan for this before it happens. Talk with your family and come up with a strategy to increase the percentage that you’re contributing to your Financial Independence.
I recommend that you increase your contributions by a percentage point for each 5% increase in pay. If your pay increases by 10% increase your contributions by 2 percentage points. If you change jobs and get a 20% pay raise, bump up the percentage that you’re saving by 4 percentage points. This is a great way for you to increase your contributions to at least 10% if you’re not already doing that. If you’re already at 10% or more it’s a good time to add on.
Here’s How Increase Your Percentage Might Work.
You’re making $30,000 a year and contributing 10%, or $3000 a year, to your Financial Independence. When you just finish your college degree your employer gives you a 10% increase in pay. Now you’re making $33,000. Because of the 10% increase in pay, you’ll now automatically be contributing an extra $300 a year because you’re saving a percentage of your pay. But, using this second method for supercharging your contributions you’ll bump up the percentage you’re contributing from 10% to 12%. Now you’re contributing a total of $3,960 a year instead of the $3,000.
Typically, in a career, these type of raises only happen a few times, so it’s good to be able to take advantage of them when they come along. This goes to show how investing in yourself can supercharge your contributions. Take classes, get a degree, volunteer for tasks nobody wants, and get experience to make yourself more valuable to the company (or to a different company). When you get that generous promotion or raise, capitalize on it and use the opportunity to bump up your saving percentage.
A windfall is when you receive a large amount of money that you weren’t necessarily expecting. Types of windfalls may include insurance settlements, inheritances, contest winnings, awards, or bonuses from work.