I had a very specific question from someone today and I thought it was interesting enough to share with the community. Perhaps a few of you out there are wondering the same thing:
“I’m 42 years old and have about 25,000$ to invest with. If I make 10% a year on my money and retire when I’m 70, how much will I have?”
At some point in the future I’d like to do an extended video on this subject to really expand on it because of course retirement planning is very important, it’s the reason you’re all subscribers. In this more simplified version today, the three most important factors when building your retirement fund are:
1) Rate of return
Now of course there’s many other factors as well (tax rate, management fees, wage growth, inflation, etc) but those three are the big ones that everyone really needs to focus on. Everyone seems to focus on rate of return, but in truth starting early and saving are just as important.
Let me show a few charts that will cover those three factors and get this conversation started. Of course if you ever have any follow up questions I’m always here to help. I can certainly plot some numbers that are more specific to your situation if you’d like:
Above we see the situation that was asked. 10% a year over 28 years should be getting close to 300,000$ and this is inflation adjusted. With regards to the first key factor, you can see the stark difference between 10% a year and 5% a year. Remember investment returns compound, so for every 1% that you can increase your rate of return you’ll get an exponential multiple of the benefit.
However that works both ways which is why we always want to focus on safety and risk management. We simply can’t afford to have years that significantly set us back. It’s better to make less from year to year and avoid catastrophe than it is to have big years and then major downer years. As I’ve always said:
“Losses are more costly to a fund than gains are beneficial” – Brent Osachoff
There are people who are still feeling the set back from the financial crisis, and that was 9 years ago. Unfortunately many people have experienced the severe negative effects of major investment drawdowns.
So clearly rate of return is important, 10% a year is far better than 5%. But you can also see in the chart how important time is. Those lines start going parabolic if you stretch out the years longer so of course whenever possible, start as early as you can.
But how about savings. How much of a difference does it make?
Now we’ve added a savings of 500$ a month as well as a wage growth of 1% a year and you can see what a difference it makes. Now the 25,000$ after 28 years could be nearly 1 million dollars. That money will be taxed at the end because this is being done in a tax deferred account, but still the addition of monthly savings can significantly boost long term performance.
I can only help you with one of these key factors, rate of return. Remember rate of return doesn’t mean one year. Most of us will be building our retirement funds over the course of several decades so we always have to stay focused on the long-term. Rate of return over 30 years is all that matters.
We can’t add time to our lives unfortunately, we all just have what’s in front of us. Of course there are always ways to feel regret for not starting sooner, but the next best thing to a time machine is starting NOW.
Lastly, savings, and this is something that I can’t help you with but I certainly can express to you the importance of it and maybe that in itself will be an assistance. Whatever you can save, even if it’s just an extra 100$ a month, do it. Your future self will thank you for it.
Rate of return + Savings + Time = Our future selves smiling
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