We often tell students that they should save X% of their salary for retirement and for general savings.  Why not make this decision more concrete and tangible by showing them the impact of this decision on 1) the short term and how quickly they can build an emergency savings fund  2) the long-term and how they can build a retirement account?

Here is a quick activity to help them see the impact of these decisions:

1)  Short-term Emergency Fund:  most experts agree that a 6 month emergency fund should be one of the primary goals of a recent college graduate.  Why?  I call it the “sleep better at night” fund.  Lose a job?  Well you have 6 months of savings to carry you.  Need a car repair?  No problem.

Recall that this fund should cover 6 months of expenses.  For a recent college graduate earning $40,000, one scenario would be that annual expenses would be about $30,000 meaning after-tax they would be spending about what they earned.  With this fact base, ask students to calculate the time to having a sufficient emergency fund saved, assuming varying savings rate:

a.  5% savings rate:  The goal is to save 6 months of living expenses.  With annual living expenses of $30,000, six months of expenses would be $15,000, so that is the goal.  If you save 5% of $40,000 that would amount to $2,000 saved per year.  At this rate, it would take 7.5 years to create this emergency fund ($15,000 goal/$2,000 saved per year)

b.  10% savings rate:  Target emergency fund of $15,000.  Saving 10% of $40,000 amounts to $4,000 per year so it would take 3.75 years to build an emergency fund ($15,000/$4,000)

c.  15% savings rate:  Target emergency fund of $15,000.  Saving 15% of $40,000 amounts to $6,000 per year so it would take 2.5 years to build an emergency fund ($15,000/$6,000)

d.  20% savings rate:  Target emergency fund of $15,000.  Saving 20% of $40,000 amounts to $8,000 per year so it would take less than 2 years to build an emergency fund ($15,000/$8,000).

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2)  Long-term retirement fund:  Using this 401(k) Calculator, calculate how much you would save based on the following assumptions.  Have students calculate the value of 1) 401(k) balance after 40 years  compared to 2) Dollars they personally contributed (excluding company match) for each scenario (need to VIEW REPORT and Cut and Paste into Spreadsheet to calculate) to find answer.  3)  401K Value to Employee Contribution Multiple

a.  5% savings rate:  Assumptions:  Percent to Contribute of 5%, Annual Salary of $40,000,  Number of Years to Save:  40 years, Current 401(k) Balance of $0, Estimated Salary Increase of 3% (roughly the rate of inflation), Employer Match of 50%, Investment Rate of Return of 6% (conservative since stock market returns have averaged 8-9%/year).

Answer:  1)  401(k) Value:  $752,908    2)  Employee Contribution:  $150,802      3)  Multiple:  5.0X

b.  10% savings rate:  Use same set of assumptions except change Percent to Contribute to 10%.

Answer:  1)  401(k) Value:  $1,505,816      2)  Employee Contribution:  $301,605   3)  Multiple:  5.0X

c.  15% savings rate:  Use same set of assumptions except change Percent to Contribute to 15%.

Answer:  1)  401(k) Value:  $2,258,724    2)  Employee contribution:  $452,406    3)  Multiple:  5.0X

d.  20% savings rate:  Use same set of assumptions except change Percent to Contribute to 15%.

Answer:  1)  401(k) Value:  $3,011,632    2) Employee contribution:  $603,210      3)  Multiple:  5.0X

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What’s the takeaway for the 401(k) calculations?

• An employer match is worth a lot so take advantage and “maximize the match” (Good PSA slogan!)
• Compound interest is a powerful tool; at a 6% return, you double your savings every 12 years.

About the Author

Tim Ranzetta

Tim's saving habits started at seven when a neighbor with a broken hip gave him a dog walking job. Her recovery, which took almost a year, resulted in Tim getting to know the bank tellers quite well (and accumulating a savings account balance of over $300!). His recent entrepreneurial adventures have included driving a shredding truck, analyzing executive compensation packages for Fortune 500 companies and helping families make better college financing decisions. After volunteering in 2010 to create and teach a personal finance program at Eastside College Prep in East Palo Alto, Tim saw firsthand the impact of an engaging and activity-based curriculum, which inspired him to start a new non-profit, Next Gen Personal Finance.

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