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What You Don't Know, About Saving for Retirement

Like the ubiquitous, annoying, will-it-ever stop GEICO commercials, I plan on telling you something you likely know, and something you probably don't know, about saving for retirement.

We all know that starting to save early is a good thing. The magic of compound interest means that a dollar saved now is worth more than a dollar saved later since the earlier effort has more time to grow. Thus, if your goal is to amass $1 million by age 65, here's how much you have to save beginning at different ages (assuming an 8 percent growth rate):

  • Age 25  $300/month
  • Age 35  $700/month
  • Age 40  $1,050/month
  • Age 45  $1,700/month

But as the financial advisor Michael Kitces points out in the Journal of Financial Planning, when you first start saving, the growth of your portfolio is influenced mostly by your contributions. Over time, however, investment returns become paramount.

This makes sense when you think about it. In the beginning, the monthly contributions constitute a relatively large percentage of the total portfolio. These contributions are driving the portfolio growth. But when the portfolio reaches a substantial number, like $500,000, the monthly deposits have a much smaller impact -- you are now reliant on investment returns.

It takes 30 years to attain $500,000 when saving $300 per month with an 8% return. Yet it takes only another 10 years to reach the $1 million mark after that. The investment returns in the later years allow for such a rapid increase in value.

There is a risk in relying on strong investment performance in the later years to reach your goals. Your returns may not match expectations. As a consequence, you may have to postpone your desired retirement date due to insufficient funds.

This proposition can be seen in a situation in which a portfolio earns 6% annually instead of 8%. In this case, saving more over a short period of time achieves a better result than small savings over a longer time frame:

• Age 25  $300/month for 40 years    $586,000 ending value
• Age 45  $1,700/month for 20 years $789,000 ending value

What is the take-away? Starting to save as soon as possible is important, but saving a little bit regularly over a long period of a time may not be sufficient. You also need to save as much as possible so as not to unduly rely on investment returns.

There are no magic silver bullets. Save early. Save more.


Words of Wisdom

A cucumber should be well-sliced, dressed with pepper and vinegar, and then thrown out. -- Samuel Johnson

[Not particularly relevant. I actually like a good cucumber salad. My wife makes a great one if you want the recipe.]