By Michael D. Bird, CFP®, MBA
At this time of year we naturally look ahead to the holidays coming at us. But before everything gets too busy, look even further ahead and think about how you’d live in retirement. By taking a small amount of time now, you can see far ahead and set up your retirement plan. Why can’t it wait? Because if you do something now, it should take less money to realize your goal. Let’s see how.
One of the first principles of financial planning is the time value of money. Put another way, a dollar today is worth more than a dollar in one year. How is that? Inflation. The price of almost everything you buy usually goes up every year. We are experiencing inflation rates of about 2% right now; a dollar today will only buy about 98 cents of goods next year. If you compare that dollar in about twenty-five years, your dollar then will only buy about 60 cents of goods. (ref: bankrate.com) By waiting, you lose the ability to put aside today’s dollar and have it grow to overcome inflation. That’s why it’s important to do something sooner rather than later.
The way inflation works against your dollar, investments work for your dollar. By having your dollar earning interest, the dollar today could become a dollar plus 5 cents in a year. Again considering twenty-five years into the future, the dollar could become over $3. All of this is possible because interest compounds, in this case for you. The investment earning 5% earns 5 cents for every dollar and then, the next year, the $1.05 is earning interest, and the next year, and so on. The interest starts earning interest and compounds on itself. It’s this power of compounding that is so powerful and can work for you or against you.
One way that compounding works against you is in the debts that are owed, especially if it’s a credit card. The 5% compounding is incredible. Think about what an 18% interest rate on your credit cards does to what you owe. If you owe $1000 on your credit card, the interest alone is $180 per year. In order to pay it off in ten years, every year requires a payment of over $222. So, you’ve paid over $2200 in that 10 years for a $1000 debt. Turn that around and save $222 per year. Your balance, assuming an 18% return, is over $5200. As an investor, it would be hard to find an investment that earns 18% per year, but that shows how corrosive the credit card rates can be to your wealth. And now you know why the credit card companies love for you to carry a balance!
Not convinced yet about starting early? Consider the person that wants to start saving at age 25, hypothetically earns 8% on their investment and wants to have enough for retirement, say $2 million. By putting aside about slightly more than $7,700 per year, they would be set. If they decided to wait until age 30, their savings rate goes up to over $11,600. The five years of waiting requires another $3900 per year. Waiting until age 35 is worse; now to achieve their $2 million goal they have to save more than $17,650 per year. That’s buying a car every year until retirement!
Compounding is powerful, and by starting early, that power goes to work for you. The sooner that saving is started, the better off you are. By starting early, the investment returns make it possible to retire earlier. Or to change careers. You get to choose!
That’s great if you’re 25. What if you haven’t started early? Now what? It’s never too late. Consider a 65-year old couple. Statistically there is a good chance that one of them will be alive at age 95. That’s thirty years. Even starting then will help. So, no matter how much past 25 you are, you’ll be better off. You just need to start.
Retirement will come to all us, one way or another. We will either choose when we stop work, or it will happen despite what we want. There’s no way to know how it will happen, but there is a way to be prepared. And that’s to start now! This month. This week. Today.
You can help yourself and your retirement savings by improving your rate of return. One of the biggest mistakes that many people make is to be too conservative at an early age. Your money needs to work, and by encouraging your investments to earn more than a few percent, it can really work hard and grow by compounding the interest. Another mistake is to be too conservative with all of your money. Some of it needs to continue to grow, even in retirement. That discussion is for another day.
The time to start your retirement planning is now. Get a retirement income plan based on your current savings and see where you would end up. You might be surprised. Of course, the earlier the better. This is truly a case where a little knowledge is very powerful. Start today. Your future financial wellness could be much better!
Michael Bird, a Financial Advisor with Secure Money Masters in Bristol, TN, is also an adjunct Professor of Finance and has taught at several universities and colleges, including ETSU, Belhaven College and the University of Memphis. He currently teaches a course on Social Security and how to integrate Social Security benefits with Retirement Income. He can be reached at the Bristol, TN office by calling (423)789-2000.
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Disclaimer: This commentary is provided for educational purposes only. The information, analysis and opinions expressed herein reflect my judgment as of the date of writing and are subject to change at any time without notice. They are not intended to constitute legal, tax, securities or investment advice or a recommended course of action in any given situation as it does not address or account for individual investor circumstances. Please keep in mind that no single strategy is the best choice for all investors/retirees. Before investing, investors are encouraged to speak with a financial professional who can help evaluate decisions based on an investor’s complete financial picture and an investor’s time horizon and risk tolerance. Past performance does not guarantee future results. An investment in stocks or mutual funds can result in a loss of principal.