Paul A. Merriman
If you’re saving money for retirement, there are four important lessons I hope you’ll learn. I’ll back them up with some numbers.
These may not be new, but they will be crucial to your success.
Lesson 1: When you start saving, the amount you invest will make more difference than your choice of investments. (This assumes you’re not trying to take chances on individual stocks or commodities.)
After 10 years of steady savings, the majority of the dollars in your account likely will be dollars that you put in, not dollars you earned. But if you let this lesson discourage you, you’re flirting with failure. Long-term investing works only if you keep going.
Lesson 2: Like it or not, luck will play an important part in how successful you are. This applies to good luck as well as bad luck.
If you begin saving money near the start of a strong bull market, you’ll feel confident. But if the market goes into a painful downward slide just as you’re getting started, a bear market might make investing seem pretty stupid. (Hint: It’s not.)
Lesson 3: Over the longer term, your choice of investments has an enormous impact on your ultimate success. The good news is that we know a lot about what worked well in the past. The bad news is that we know nothing about what’s going to work well in the future.
Lesson 4: Despite all that, there is one surefire way to do better when you’re saving for retirement: Save more.
I’ll show you some numbers based on assumptions of somebody saving $1,000 a year. In every case, if you saved $1,500 a year instead, you’d have half-again as much in the future.
If you can do this for 30 or 40 years, depending on how much you save, your choice of investments — and that all-important factor of luck — that extra 50% could add millions of dollars to what you have when you retire.
The numbers I’m going to cite come from some tables available on my website. They show actual year-by-year returns and results from 1970 through 2020 for portfolios with various combinations of stocks and bonds.
They all assume an investor added $1,000 a year ($83.33 a month) in 1970, then increased the contribution by 3% every year to cover presumed inflation.
Let’s loop back to Lesson 1. As you can see in Table 73, if your monthly investments all went into the S&P 500 /zigman2/quotes/210599714/realtime SPX +1.49% in 1970, you ended the year with $1,022. That $22 gain wasn’t very impressive!
If you continued that plan for 10 years, your contributions totaled $11,465. At the end of 1979, your account was worth $16,270. Did that make you feel you were on the way to becoming a millionaire? Probably not.
The majority of that year-end balance, about 70 cents on the dollar, came from your own pocket.
In the second decade of your plan, you added an additional $15,408. Your year-end balance in 1989 was $120,320, giving you a gigantic payoff for sticking with the plan.
Of that total, just $26,873, or about 22 cents on the dollar, came from you. The rest was what you earned.