Buying a home can seem out of reach for many renters, especially when a lack of affordable housing combines with stagnant wages.
That’s sparking fears for the long-term financial outlook of millions of people who, by either necessity or choice, aren’t becoming homeowners.
Homeownership, after all, has long been seen as a key element of setting yourself up for a comfortable future.
The story used to go like this: When a homeowner reaches retirement, they’d use their house as a nest egg. They’d borrow against the equity they’ve built up in their home to pay for their new, post-work lifestyle. The home equity loan and home equity line of credit are two of the popular financial instruments that come in handy in this process.
While homeownership may still be a part of the American Dream, it’s not necessarily the only way to fund your nest egg for retirement. In fact, it may not even be the best way.
“Home ownership is not a very effective way to accumulate long-term wealth for retirement, despite conventional wisdom suggesting the contrary,” says Robert Johnson, PhD, CFA, a professor of finance at Creighton University.
So it turns out that homeownership isn’t a one-size-fits-all retirement strategy. Using your home to fund your retirement could be tricky, as you won’t know its future value—and a recession could cause it to lose value.
Don’t loss hope, though. Whether you can or can’t afford a home, there are several other ways to build a nest egg for retirement.
Create and commit to a spending plan
Before diving into saving, start with the basics and figure out where your money is going. After factoring in the essential bills like housing, food, transportation, and utilities, designate a certain percentage of your income to retirement savings. While everyone’s financial situation is different, TIAA recommends that people save about 10-15% of their income for retirement.
Creating a budget doesn’t have to be too fancy or complicated. It just has to help you stick to your goal. Even if you don’t feel like you make enough money to make an impact on your savings, it’s still best to start with whatever you have. After all, some retirement savings is better than zero.
“Too often people rationalize that they will begin saving when they make more money, only to realize that it is easy to simply let spending increase commensurate with salary,” says Johnson. It’s a phenomena often referred to as “lifestyle creep.”
Harness the power of compound interest
When saving for a long-term goal, time matters. Compound interest is critical for growing your money over time, as it builds interest on interest. Compound interest works best when you save consistently and as much as possible. Starting early will allow you to take advantage of its power.
Compound interest can multiply your savings. For example, if you deposited $100 monthly in an account with a 3% rate of return that compounds annually, you’d end up with over $57,000 in 30 years.
Use retirement accounts to fund your nest egg
Maxing out retirement plan contributions on a 401(k) or IRA (an individual retirement account) is a simple yet effective way to build up your nest egg for long-term growth.
First off, your contributions can be made pre-tax. So, not only does contributing to your retirement account give you a chance to accrue savings, it also reduces your current taxable income.
Tying up your money in a retirement account can keep it safe from its worst nightmare—yourself. We’re kidding (sort of), but a traditional retirement account makes withdrawing money just a little bit harder. Withdrawing from these accounts before you reach retirement age can trigger penalties, so you’ll be less likely to rashly blow any of this cash on things you don’t desperately need.
The whole point of a nest egg is to accrue compound interest and grow your savings tax-free. If you use these accounts for what they are intended for, you’ll be making moves that will pay off in the future.
The 401(k)
A 401(k) is considered a defined contribution plan offered by employers. It’s a retirement account that allows you to make automatic deductions from your paycheck.
Treat your company’s 401(k) as the benefit it is—and take full advantage of it. In the private sector, only 75% of employees with access to retirement benefits chose to participate, according to the U.S. Bureau of Labor Statistics. Access to a 401(k) is an effective way to build up a nest egg. FYI, in 2022, the 401(k) annual contribution limit is $20,500.
In addition to your own contributions, many companies offer some type of match; if you’re currently job-hunting or interviewing, be sure to ask your prospective employer if they do.
Employees may receive a dollar-for-dollar contribution match up to a certain percentage of their annual salary, a partial match which only matches a portion of an employee’s contribution, or even automatic contributions to their 401(k). Whatever the case, use this gift by contributing enough to earn the full company match.
The IRA
For those without access to a 401(k), an IRA can be your retirement account of choice to grow your money overtime. Note that opening an IRA account with your financial institution of choice only can be done online.
Invest in a low-cost index fund
The skyrocketing price of NFTs and cryptocurrencies can tempt investors trying to build their nest egg that way—after all, social media newsfeeds are full of people who got rich, quick. What if you bought into a trendy, new cryptocurrency that increased in value 200% in a matter of days?
But on the other hand, you could end up with an investment that’s worthless in a matter of days. While adding nontraditional investments to your portfolio could pay off, they are volatile and may not be the safest solution for long-term stability.
While lacking in sex appeal, the humble, broad index fund—a type of mutual funds or exchange-traded fund (ETF)—can be a strong place to build up your savings over time. Index funds are also a tried and true investment strategy for billionaire Warren Buffet, for instance. They’re also the subject of endless, perennial op-eds counseling investors to save money the “boring” way.
“Equities have traditionally outperformed real estate,” says R. J. Weiss, a certified financial planner. “In a way, renters can be at an advantage in growing wealth over homeowners, as more of [the renter’s] net worth is tied up in a higher-performing asset.”
Index funds have low fees and offer diversification. They’re considered a passive investment strategy, so you don’t need to be a market strategist to invest in one and reap the rewards. Their gains are also greater than those of the housing market.
Build your nest egg your way
Every person’s finances are unique and personal, and it’s always the best idea to consult with a personal financial advisor before making any major decisions.
While homeownership may be the best retirement vehicle for some, don’t feel the peer pressure to buy a home if it doesn’t make financial sense. Making savvy investments can set you up for success even if you continue renting into your golden years.
A few quick words, because we <3 our lawyers: Lemonade articles and other editorial content are meant for educational purposes only, and should not be relied upon instead of professional legal, insurance or financial advice. This information does not take into account your individual financial goals, situation, or needs and we do not offer financial advice, advisory or brokerage services, nor do we recommend or advise individuals to buy or sell particular stocks or securities. The prior performance of any investment is not a guarantee of any future results. If you choose to make any financial investment or acquire any product mentioned on this page, you should obtain and review the terms and conditions relating to that product and also seek independent financial, legal, and taxation advice.
