“Contribute at least x% of your income” has been a widely adopted retirement savings rule of thumb. This strategy has provided tens of millions of retirees with a fruitful retirement. So why fix a method that isn’t broken?
According to a Gallup poll, the average investor starts saving for retirement at 29. With most Americans retiring at 65, this leaves 36 years to save.
In the chart above, the investor contributed $432,00 towards their retirement. With growth, the portfolio grew to $1.9m – not too shabby.
The downside of the strategy – annual funding lasted 36 years.
An Alternative Strategy
As an alternative, let’s double the annual contribution but only make them for 10 years.
In this scenario, the investor made $240,000 in contributions over 10-years, then never made another contribution. With growth, the portfolio grew to $2.06m.
They contributed $192,000 less than the Traditional Path of Saving for Retirement Scenario. Yet, at 65, the account value is nearly $150,000 more. While it seems illogical to contribute less but have more, this is the power of compounding.
Simple Interest vs. Compound Interest
Simple Interest – The interest earned only on the initial principal. Think of owning CD.
Compound Interest – The interest earned on the principal and the interest that accumulates every period. Think of your investment account(s)
It’s believed that Albert Einstein said compound interest is the “…most powerful force in the universe…compound interest is the eighth wonder of the world. He who understands it, earns it…he who doesn’t…pays it.”
Why Rethink Retirement Savings?
Most of us will navigate significant life decisions tied to money. Everything from buying a home, career transitions, starting a business, having children, paying for education, funding our retirement, and everything in between. Having financial flexibility can make many of these decisions easier.
Frontloading your retirement savings could provide vast amounts of flexibility, as you’ll see in the charts below. But, of course, there’s nothing wrong with consistent annual contributions, the route that we’re all accustomed to – if you plan for all of life’s major financial decisions well in advance.
The point I’m trying to drive home – it’s possible to spend 10 years with a single focus, resulting in greater flexibility in your future. The earlier you can start, the more time compounding has to take its course.
I’ll leave you with two charts. These charts show two scenarios with four different funding options. In the Traditional Retirement Funding chart, a 29-year-old saves equal amounts every year until they reach their desired retirement age, 65. Each line represents a different contribution amount. The number next to the line represents the account size at the end of the 36 years.
Traditional Retirement Funding
Alternative to Traditional Retirement Funding
In the Alternative to Retirement Funding chart, a 29-year-old saves equal amounts for 10 years. Then, no more contributions are made, and compounding takes over until the desired retirement age of 65. Each line represents a different contribution amount. The number next to the line represents the account size at the end of the 36 years.
The charts included are hypothetical illustrations and are not intended to reflect the actual performance of and particular security. Future performance cannot be guaranteed and investment yields will fluctuate with market conditions.
Any opinions are those John Geffert and not necessarily those of RJFS or Raymond James. The information contained in this report does not purport to be a complete description of the securities, markets, or developments referred to in this material. There is no assurance any of the trends mentioned will continue or forecasts will occur. The information has been obtained from sources considered to be reliable, but Raymond James does not guarantee that the foregoing material is accurate or complete. Any information is not a complete summary or statement of all available data necessary for making an investment decision and does not constitute a recommendation. Investing involves risk and you may incur a profit or loss regardless of strategy selected