Retirement Investing
by
Charles Lamson
The great thing about investing for retirement is that you can do it within a tax-deferred environment, meaning taxes are not paid on gains in your account. There are some exceptions to this rule, but it is your decision how to handle taxes.
The following examples ignore the effect of inflation because I want to impress you with my math later, when we will look at a more realistic picture.
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The Early Bird Gets the Compounding
Our first intrepid investor is Sally. At age 25, she has a promising career in accounting. She sets up a retirement account earning 10 percent and deposits $50 a month for the next 40 years. At age 65, she gets a gold watch and a check for $316,204. Not too shabby.
But Sally is smarter than that, thanks to her bean-counting skills. She knows how compounding and time can work for her. So she sets up the same retirement account earning 10 percent and deposits $50 the first month. Then every month she increases her deposit by $1. So the second month, she deposits $51 and the next month she deposits $52, etc.
Now at age 65, she gets a gold watch and a check for $1,011,276! That is over 319 percent more, and all she did was add $1 a month. Her retirement fund grew by over $695,000 and she did it by adding $1 each month.
Besides the magic of time and compounding, this example raises another good point. Some of you who are clever in math figured out that Sally was depositing over $500 a month toward the end of her career.
That may seem like a lot, but consider Sally's strategy. By forcing herself to increase each month, even if by only a dollar, she established a disciplined approach to her investing. This conditioned her to not miss that additional dollar each month (or payment, either). Besides, when you figure a modest 3% annual inflation over 40 years, $500 will be the equivalent of about $150 of today's dollars.
TIME SAVER
Get to know the Rule of 72. To determine how long it will take for an investor to double his or her money, divide the fixed rate of compound interest into 72. For example, at 10 percent interest, it will take 7.2 years to double. To you this means that $10,000 today, invested poorly at 2 percent, will be $20,000 in 36 years. Big difference!
Better Late Than Never
Our next hero is Bob, age 50. Bob always wanted to set up a retirement account, but somehow just never got around to it. As a moderately successful kumquat salesman. Bob has a moderately growing income thanks to residuals. (Residuals are commissions on sales paid out over time.)
After reading this blog, Bob boldly commits to establishing a retirement account, which he opens with $1,000 from his annual bonus. Each month he deposits $250 into the account, which is earning 10 percent. Each year he adds another $1,000 from his bonus and ups his monthly contribution by $25. While Bob will not become a millionaire this way, he will build a nest egg of almost $194,000. Not bad, considering he started with nothing.
Comparing Sally and Bob further reveals the power of compounding and the magic of time. Sally's total investment in her retirement is $138,431 and it yields over a million dollars. Bob's investment is $91,500 with a yield of almost $194,000.
Sally gets a return of over seven-fold on her investment, while Bob just doubles his money---not bad, but think where he would be if he had started earlier. More importantly, Bob has less time for maneuvering. Because Bob started late, he cannot afford to try different strategies and take a chance that he will get caught in a down market just when he needs to start living off his investments.
With 15 years to work with, Bob can up his nest egg by increasing his monthly contribution by $25. So every year he ups his monthly contribution by $50 over the previous year. This is probably going to pinch his lifestyle.
It does manage to get his total up over $247,000 with an investment of $123,000 but you will notice his yield is still just barely double.
More about retirement investing, compounding and so on in later posts, but I hope I have convinced you that there is some urgency for you to get started with your own investment program.
To be continued...
*SOURCE: ALPHA TEACH YOURSELF INVESTING IN 24 HOURS, 2000, KEN LITTLE, PGS. 7-9*
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