The year was 1985 in the city that never sleeps. A young, ambitious junior stockbroker was set on making a name for himself. He soon found himself with an opportunity to work for one of the wealthiest fund managers on Wall Street.
This unknown broker went from sleepless nights in a small apartment to a luxury penthouse on the upper east side of Manhattan. His desk at a crowded office quickly became a corner office with a view. Lavish parties, overpriced artwork, and high-end cars became his new normal as money was no longer a concern of his.
This is often the glamorous overnight wealth picture Hollywood paints of the stock market. This was also the picture Hollywood painted in the 1987 dramatic film “Wall Street.” Unfortunately for our hero Bud Fox, as quickly as all his dreams became true, they came crashing down.
Sadly, what we will cover in this article, while not quite as dramatic, has become a reality for many individuals today.
Retiring Comfortably Is Harder Than It Seems
The promise of easy money has become an unrealistic selling point for many financial professionals. However, there is no secret to success or “magic pill” for retirement savings.
We are going to break down the three keys to success for retirement savings. I’ll warn you now that they aren’t very glamourous or as exciting as the film “Wall Street.” However, I’ll be showing you a retirement equation of sorts; and if you have all three factors in this equation in your retirement plan, it will equate to success at the end of your retirement savings journey.
So, now that we’ve gotten the movie reference out of the way, let’s continue and put this all into practical application.
A Realistic Retirement Plan With 3 Focus Points
I often speak with new clients who state they were told by their investment advisors, “just put one hundred dollars a month away and you’ll be a millionaire when you retire.”
While certainly a strong selling point, this statement is not based in reality. In fact, if a person put away one hundred dollars a month for fifty years with an annual rate of return of 7.2%, they would have a total of $559,940.34 at the end of those fifty years. While certainly a large number, this is a far cry from the million dollars they believed they would have.
This calculation also includes an optimistic rate of return and a timeline that is well beyond what most investors have. This scenario does, however, identify the three major areas of concern when planning for the future. These are the three factors of our successful retirement savings equation:
- Years of growth/time
- Principal & contributions
- Rate of return
Controlling Our Retirement Savings Plan
Fortunately for us, we are able to control the amount of principal and the years of growth. While, in most cases, the rate of return cannot be guaranteed, a person can use past performance and appropriate investment choices to estimate a reasonably accurate anticipated rate of return.
Knowing what we can control, we can take a look at a few scenarios and see the impact of adjusting each.
1. Using Time To Our Advantage
First, assume a person invested $100 per month for twenty years with an average rate of return of six percent. At the end of twenty years, this person would have accumulated $46,791.27. Not too shabby for a total investment contribution of $24,000.00.
Now we’ll run this same scenario but with an investment period of thirty years. At the end of the thirty years, this individual would have a total of $100,562.01, having contributed a total of $36,000.00. Simply put, for an extra $12,000.00 in contributions, this individual would have an additional $53,770.74 in accumulated value!
This is the power of one of the variables we can control, which is time. This also shows the power of exponential compounding growth, which is critical in building wealth. If these scenarios show one thing, it is that the best time to start investing is ASAP. Start with what you can afford and build over time. There will be no “perfect time” to start, and time is a finite resource that we can never get back.
In other words, once the time is gone, …it is gone.
2. Making Your Money Work For You
Now let us take a look at another variable we can control being principal or contributions. We will circle back to our previous example for comparison. Let’s look at our twenty-year scenario.
In this scenario, if we were to invest $200 per month versus our previous $100 per month, our final result would be an account value of $93,582.54. If you remember, our last scenario left us with an ending account value of $46,791.27.
Maximizing contributions is critical to building wealth as quickly as possible.
Since we now understand the importance of starting early and maximizing contributions, let’s look at what thirty years of investing $200 per month with a six percent rate of return can do for us.
The account value at the end of this thirty-year scenario would be $201,124.03. Simply put, the key to building wealth is starting as early as possible, combined with maximizing contributions. There is no other “secret.”
When asked why more people do not duplicate Warren Buffett’s investing strategy, he responded, “because nobody wants to get rich slow.” However, slow and steady often wins the retirement savings race.
3. Understanding Your Rate Of Return
Now for the third variable in our equation, the rate of return. While most investments will not guarantee a rate of return (if they do it is typically fairly low), you can use past, historical performance to make an educated projection of how an investment will perform over the long term.
It is important to choose investments that fit your risk tolerance and investment time horizon. More so than principal or time, this can be the one variable that genuinely makes or breaks an investment portfolio.
If you are not comfortable in choosing appropriate investments, it is wise to seek the advice of a trusted financial professional (preferably one who is a true fiduciary). A fiduciary is someone who is obligated to put your interests above their own and do the truly right thing for you.
Don’t Forget About Taxes
While you are building wealth, another factor to consider is your tax liability. If planning for retirement, it is usually best to keep your investments in a tax-advantaged account. This can include 401k plans, 403b plans, or 457b plans available through your employer. If your employer does not offer any tax-advantaged accounts, you may consider a traditional IRA or Roth IRA account.
A Roth IRA account will provide tax-free withdrawals when you reach the age of 59 ½, provided you have held the account for five years or longer. The other accounts will provide pre-tax benefits but will be taxed as ordinary income upon withdrawal at your future tax rates.
If you need to access your money before retirement, it may be appropriate to keep a portion of your money in a non-qualified account or alternative investment vehicle. I covered this topic in my Alternatives to Roth IRA’s article.
A Formula For Retirement Saving Success
Just to quickly recap, the equation for building retirement wealth is:
Maximizing time (starting early) + maximizing contributions + choosing appropriate investments = SUCCESS.
These are all very simple concepts and if you have these three factors in your retirement savings equation you will greatly improve your chances of success. Simply combine this simple strategy with the utilization of tax-advantaged accounts and you will be living the retirement of your dreams.