By Paul A. Merriman, MarketWatch
There isn’t much about the future that I can predict, much less guarantee to investors.
But here’s one thing I can guarantee: If you achieve as little as 0.5% extra annualized return on your portfolio while you’re accumulating assets — and continue to do so while you’re retired — you will be many, many dollars ahead.
The difference can change your life as well as the lives of your eventual heirs. Much of your investment returns will be determined by things outside your control.
• Were you fortunate enough to be born into a family that provided you with a good education, good financial examples, and maybe even a trust fund?
• Or did you have to scramble for every dollar and every advantage?
• When you’re near retirement or when you finally do make the leap, does the market suddenly take a big turn for the worse and force you to say goodbye to a lot of the money you have saved?
Those and other major factors such as your health certainly shape your financial future.
But how well you do financially over a lifetime is also affected by how well you play whatever cards fate deals you. A good place to start is to grasp just how big a deal that paltry 0.5 percentage point of long-term really is in the long term.
Imagine you and your twin sister are celebrating your 21st birthday together. You decide you’ll each invest $5,000 at once and add the same amount on every subsequent birthday until you reach the “new” expected retirement age of 67.
Now imagine that — for whatever reason — your sister achieves an annual return of 8.5% for that whole period, while your own retirement money earns only 8%.
Let’s ignore taxes and assume you’ll each do this within a Roth IRA.
Your first investment occurs on your 21st birthday, your final one on your 66th birthday. Those 46 investments cost each of you $230,000.
On your 67th birthday, you and your sister compare notes as you prepare to take your first annual retirement withdrawal. You both agree that on this and every subsequent birthday, you’ll each take out 4% of the balance in your account.
If you have carried out this plan faithfully, your Roth IRA should be worth about $2,259,500; your sister’s should be worth about $2,657,300. Just that difference, nearly $400,000, is considerably more than all the annual savings that either of you added over the years.
Your sister’s higher portfolio value on your shared 67th birthday is the first of three financial results she gets for earning an extra 0.5% along the way. The other two are bigger.
You withdraw 4%, or $90,380, for the following year to supplement your Social Security (which we hope will be there) and the other resources you have to support your retirement.
Your sister’s first 4% withdrawal is $106,292 — giving her noticeably more for that first year of retirement. (Maybe she’ll pick up the bill the next time the two of you go to dinner!)