January 7, 2007; The New York Times (nytimes.com)
By Paul J. Lim

FOR some investors, the new year offers a reminder to rebalance their portfolios. Others use this time to make tactical, short-term bets on certain stocks or commodities. But many investors often overlook the simplest step of all: increasing the amount of money they set aside in their 401(k) retirement plans, individual retirement accounts and other savings vehicles.

Indeed, a study of the behavior of 401(k) investors by Hewitt Associates, a consulting firm in Lincolnshire, Ill., found that only 16.6 percent of 401(k) participants increased their contribution rates in 2005, the most recent year for which data are available. Nearly 10 percent, meanwhile, wound up reducing their savings rate that year.

Yet without adequate savings, no investment strategy will take you to where you need to go. “Savings is literally the gas in the retirement car,” said Richard Rosso, a Houston-based financial planner at Charles Schwab, the brokerage firm.

Socking away more money may not seem as sexy as finding the next Google or timing the commodities market. Yet for many people, this step will have a more meaningful impact on the long-term success of their investment plans than how well they invest their money.

Say you save $1,000 a year for the next 25 years and earn 7 percent annually on your money. At the end of this time, you would end up with slightly more than $67,000 in your account.

Now let’s assume that you tweak your investment strategy and increase your returns by two percentage points a year. In this case, you would raise your portfolio value to $92,000 — but you would be assuming more risk in your portfolio to achieve those higher returns.

But if you simply socked away an extra $1,000 a year, you would end up with $135,000 — and that assumes the original 7 percent rate of return.

“Fundamentally, savings is the most important topic in retirement,” said Jamie Cornell, senior vice president for plan sponsor marketing at Fidelity Investments. “We can talk long and hard about all the different investment vehicles out there, but Americans today are simply not saving sufficiently.”

It isn’t that people are avoiding all saving: an annual survey of the Employee Benefit Research Institute recently found that 70 percent of workers have saved for retirement.

But it’s how much — or rather, how little — they are setting aside that is worrisome. The fact is that nearly two-thirds of all workers have saved less than $50,000 toward their retirement, according to the survey. And 77 percent of all workers have less than $100,000 accumulated.

The good news is that the Pension Protection Act, signed into law last August, made permanent the higher annual contribution limits for IRAs introduced in 2001. This year, for instance, investors can put as much as $4,000 into their IRAs, while people 50 or older can add throw in $1,000 on top of that, as their so-called catch-up contribution.

Moreover, contribution ceilings for 401(k)s have increased. In 2007, workers can contribute up to the federal cap of $15,500. That is $500 more than in 2006. And employees 50 or older can stuff an additional $5,000 into their accounts this year. Not all workers are allowed to save up to the federal limit, however. The ability of the highly compensated to contribute up to the federal maximum is often influenced by how much rank-and-file workers are saving.

Mr. Rosso suggests that all workers who aren’t maxing out their 401(k)s consider raising their salary deferral rate by two percentage points.

In other words, if you now contribute 6 percent of your pretax salary to your 401(k), see if you can increase that to 8 percent.

Workers who have recently enjoyed a pay raise or bonus “probably will never feel the loss in their take-home pay,” Mr. Rosso said.

But can two percentage points make much of a difference? T. Rowe Price, the investment management firm, crunched the numbers. Say you earn $32,500 a year in salary. And assume that you currently contribute 6 percent of your pay to your 401(k). That means you are saving $37.50 a week. If you invest that money for 30 years and earn 8 percent annually, you would end up with $243,820.

But say you were to increase your deferral rate to 8 percent. That extra two points of savings, compounded over 30 years, would increase the size of your nest egg by a third — to $325,093. And if you were to save an extra four points, raising your deferral rate to 10 percent, you would have two-thirds more money — or $406,366.

THE younger you are, Mr. Cornell noted, the more impact that incremental increases in your savings rate will have on your overall plan through compounding.

For instance, if you are 25 and have 40 years until retirement, every additional $1 you save will be worth $8.14 at retirement, adjusted for inflation. That is according to an analysis by Fidelity that assumes you invest that money in a mix of 70 percent stocks, 25 percent bonds and 5 percent cash.

But if you wait until you turn 40, each incremental dollar of savings will be worth $3.87 at retirement.

Does this mean that at a certain point, it isn’t worth saving? Not at all. Even at 50, a dollar saved will be worth $2.32 by the time you turn 65.

It just means that it’s important to start saving now — or as soon as humanly possible.

Paul J. Lim is a financial writer at U.S. News & World Report. E-mail: fund@nytimes.com.

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