A “nest egg” generally refers to retirement accounts. It’s the money you save for the future so that you have something to fall back on when you retire. Oftentimes, growing your nest egg is the stated goal of a financial plan. But what do we mean when we talk about a nest egg, and how do you grow it?
It’s important to put part of your paycheck aside while you’re working to build a strong retirement plan. This will help you have income to support yourself after you retire. There’s no single correct amount to save for retirement. For example, a $500,000 nest egg may be a good amount, but some retirees may be able to live on less than that. Others may need more than that, depending on where they live and how many dependents they have. If you want to figure out what size your nest egg should be, a retirement calculator can help.
Why Build a Nest Egg Now?
If you can afford it, consider growing your nest egg right now. If you haven’t, start today, no matter your age. The sooner you start saving, the more money you’ll be able to accumulate because of interest and compound interest. Retirement accounts like a 401(k) or IRA are investment accounts, too, so the money you save will grow over time.
For example, imagine you put $100 into your retirement account and generate an average annual return of 7% over 30 years. With a 7% annual return, your $100 will have turned into $761 in that 30-year period.
If you want to do the math yourself, it’s the percent return divided by 100 (7/100 = .07), plus 1 (.07 + 1 = 1.07) to the power of however many years you’re investing (1.07 ^30). Then multiply that result by your original investment (100). The full equation looks like this: (100 * (1.07^30) = 761).
Your money grows in this type of situation because you’re reinvesting your earnings. The $7 you earned in the first year is reinvested. Then, the amount you’re able to invest gets bigger and bigger each year. This is true even if you never add any additional money to that account.
The longer you’re able to leave your money in the retirement account, the more you can make. If you put money in your retirement account at age 25 and plan to retire at age 65, it has 40 years of growth potential. If you put money in your retirement account at 60, that money only has five years of growth potential. The earlier you start saving, the better.
Where to Put Your Nest Egg Savings
The best place to put your retirement savings is in a tax-advantaged retirement account like a 401(k), a Roth 401(k), a Roth IRA or a traditional IRA. IRAs and 401(k)s allow you to grow your money on a tax-deferred basis. That means that you’ll have even more money to invest during your working years. You won’t have to pay taxes on your earnings until you take withdrawals in retirement.
Roth 401(k)s and Roth IRAs are also tax-advantaged, but in a different way. Although you pay taxes up front, the earnings you make in Roth accounts are completely tax-free. That means you won’t have to pay taxes when you make withdrawals in retirement. Aim to save as much as you can afford in your retirement accounts every year, but be mindful of the contribution limits.
If you have a 401(k), your employer may provide a matching incentive. Make sure you contribute enough of your own money to take full advantage of any and all matching incentives.
If your money is in a traditional 401(k) or IRA, all of your withdrawals will be taxable during retirement. That means the gross amount in those accounts is not the same as the amount that will be withdrawn when you retire. Make sure the amount you expect to have access to each year includes any taxes you may have to pay on your earnings.
After you’ve maxed out your tax-advantaged retirement accounts, you might want to consider an annuity. An annuity can provide you with guaranteed income for the rest of your life. And that can help in case you’re worrying about outliving your nest egg.
Additionally, your nest egg could include the values of other investments outside of your retirement accounts. These may include expensive artwork or rental properties in ideal locations. It’s smart to look at all of your investments when considering how much your nest egg will be worth in the future.
When you invest your money, consider looking into low-risk stocks so that your principal isn’t in jeopardy. Invest in low-risk stocks that tend to track the market because they may help account for low inflation. While $1 million may be one goal for nest eggs, in 2045 you might need almost $2.2 million to have the same purchasing power that $1 million will get you in 2019 (assuming 3% annual inflation.) Your retirement savings needs to start growing now just to make up for future inflation.
It’s also smart to diversify your portfolio so that you don’t put all your nest eggs in one basket. For example, invest in both small and large companies, as well as stocks, ETFs and mutual funds.
Try to remain patient with your investments, too. Investing is a long-term game. Don’t sell them just because the market fluctuates. If your investments been performing within one or two points of the market, consider holding on to them. Unless you have a reason to believe that your investments will be worthless in the future, they’ll most likely make money in the long run.
Budget, Budget, Budget
To grow your nest egg, save a portion of your monthly income. In order to do that, you’ll need to figure out your monthly expenses and create a budget. You should determine how much of your income you need to cover your fixed and variable expenses, plus how much you’ve been spending on nonessentials. Then you can figure out where you can afford to cut corners to put extra money toward your nest egg.
Of course, it’s always smart to have an emergency fund in place before investing aggressively. This money is for unplanned expenses that come up before retirement, such as car repairs or out of pocket healthcare costs. This way, when those unplanned expenses come up, you won’t have to sacrifice potential retirement savings to cover the cost.
The Bottom Line
Although you may have Social Security in retirement, it’s only designed to supplement your income. Nest eggs are an important part of ensuring that you’ll be financially secure when you’re older. It’s very important to save as much as possible, as early as possible, so that your investment has the opportunity to grow. With some smart retirement planning, you’ll be in a good position to cover your costs in your golden years.
Retirement Saving Tips
- Find out if you’re on track to retire. Use a retirement calculator to see if you’re saving enough and a cost of living calculator to make sure you’re not underestimating how much income you’ll need after you stop working.
- A financial advisor can help you get on track and stay on track so you can retire when you want to. Finding the right financial advisor that fits your needs doesn’t have to be hard. SmartAsset’s free tool matches you with financial advisors in your area in five minutes. If you’re ready to be matched with local advisors that will help you achieve your financial goals, get started now.
Photo credit: ©iStock.com/BrianAJackson, ©iStock.com/AJ_Watt, ©iStock.com/pinkomelet