The Most Important Factor in Retirement Savings

We’ve all been there: making decisions on the old retirement savings account. It doesn’t matter if it is a Roth IRA, a 401(k), or a deferred comp plan, there are many different decisions that we have to make.

It can be overwhelming, until you step back and realize that there are actually only three primary decisions to make:

1. How much to contribute
2. How to allocate between stocks and bonds
3. Which funds/investments to choose

Once you realize this, it becomes much easier to start the decision-making process. But here’s something about that process that I’ll wager you didn’t realize – one of those three decisions is by far more important to the overall success in your plans, and there is another factor* that you may not have considered.

The most important decision you can make with regard to your saving activity is the first one in the list – How much to contribute.

According to a recent study by Putnam, this one factor makes a much greater difference in the outcome of a savings plan than the other two can, even in the best of circumstances. By choosing to save as much as possible, we are laying the groundwork for the other items, allocation and fund choice, to optimize upon the greatest possible starting amounts.
Putnam’s study indicates that fund choice makes the largest difference in the later years of a plan, and that aggressive allocation makes a smaller difference in the earlier years.

The rule of thumb generally is that you should invest at least enough to get the maximum from your employer’s match, assuming that a match is available to you. Above and beyond that, it is important to ensure that you’re salting away as much as you can, so that compounding can begin on as large an amount as possible.

This doesn’t mean that you should not pay careful attention to allocation and fund choices – what the study indicates is that you can make a mistake here and there with allocation or fund choice, and it won’t sink the boat.

*The other factor that I alluded to earlier is having a plan, and the discipline to stick to it. That means developing goals, mapping out how (incrementally) you will achieve those goals, and then putting the plan into action – sticking to it, through thick and thin, and monitoring your progress. I know, I know, you’re saying to yourself, “what a shock, the planner-guy is advocating that we have a plan”. Touché. Okay – so I believe in what I do. I recommend that you develop a financial plan regardless of whether you hire me to do it. I sincerely believe it is the most important factor in determining success in reaching your lifelong goals.