This is the fifth in a series of eight articles expanding on the steps of the article:
8 Steps to Build Wealth
Step 5: Contribute to a Savings Plan
One of the easiest and most straightforward ways to begin building wealth is to contribute to a savings plan. Many employers offer retirement savings plans that give employees competitive advantages. In addition, there exist retirement options that workers can open up for themselves outside of their employer. As it’s different in every country, and I am not a professional financial expert, the focus of this article is not on the various specific types of retirement savings plans. Instead, this article describes the various general benefits and drawbacks of putting money into retirement savings plans.
Aside from free tax prep offered by many institutions, many retirement savings accounts have tax benefits, such as deferring taxes until decades later when the money is removed, or allowing you to pay taxes now and then earn a completely tax-free rate of return. To those that are new to investing, this may sound like a small bit of assistance, but in reality, the difference between tax-free growth and taxed growth is enormous. How much tax one pays on their investments depends on a number of factors, but it’s not out of the question that a change in how much tax you pay over the years could end up doubling the wealth in your savings plan over 40 years.
Many employer retirement plans provide matching opportunities, where they contribute money to your plan as long as you contribute to your plan. For instance, a plan might be that if you contribute 6% of your gross salary to your retirement plan, your employer will contribute another 4% of your salary. So your total contribution is 10% of your salary. This means that you’re adding an extra 66% into your retirement plan each year (10% compared to only 6%), and so you’ll have a big difference when you retire. Combine this with the tax advantages from the previous point, and you’ve got yourself a real deal here.
In addition to practical advantages of a retirement savings plan (and there are more than what I have listed), there are also subtle psychological advantages.
Saving money can be hard. There may be things you want to spend it on, and there may seem instances where you need to spend your savings on things outside of your control. A retirement savings plan that takes money right out of your paycheck automates the process for you, bypassing your emotions. By putting money into a retirement account that you never actually see in your wallet or your checking account, you’re forcing yourself to be disciplined with your money.
Contributing to a retirement savings plan is a big step to build wealth and just about everyone should do it, but there are some traps to avoid.
The first trap is that many retirement accounts invest in index funds, mutual funds, and bond funds. These are great investment tools, but they make the process so easy for you, that you barely have to know anything about investing. Like a pet that looses the ability to live on its own after being cared for in a house for so long, a person can become a financial zombie by automating their finances so well that they never actually learn a thing about it! Don’t let this happen to you; keep yourself informed about investing and know where your money is invested through these plans.
The second trap is that some people have a tendency to assume that since they are contributing to their retirement plan, they don’t have to build any wealth outside of that plan. They feel that they can spend the rest of their money “guilt free” because they’re already putting money away. This is a problem because retirement savings are not always enough to support retirement. And even if it is sometimes, this site is about building real wealth, not just getting by. That’s why this is only step 5 out of 8. We’re not about being merely average here.
So use these powerful tools but don’t let these tools rule you. There’s more to do coming up in the last three steps.