“Time is money.” — Benjamin Franklin
Although Benjamin Franklin may not have been referring to the effect that time has on money accumulating in an IRA, his words hold true with today’s investors. That is because time becomes one of the best allies for investors. But even if you did not start investing in your plan until later in life, there is another old saying that also holds true — “Better late than never.”
THREE FEATURES OF EMPLOYER RETIREMENT PLANS.
No matter where you are financially in your life or how much you already have in your retirement account, your employer’s retirement plan may have features that could help build your nest egg.
First, the advantage of compounding interest and tax-free earnings until withdrawal. Second, matching employer contributions. Third, the multiple choices of different funds to develop your financial plan.
The earlier you can put all these elements into effect, the better your financial future will be. For example, if you start at the age of 25 years old. Even if you do not have much income to spare, the smallest contribution could grow into something meaningful by retirement. For example, a two percent contribution from a $25,000 annual salary is just about $10 out of your weekly paycheck. If you increase your contribution by just two percent each year until you reach the maximum the company allows, for example, ten percent, and earn a ten percent return on your investments, you will have $1,437,543 by age 65.
INVESTING CAN BEGIN AT 40
So, many of you may not have had the good fortune of being able to start building financial nest eggs at such a young age. So, what happens when you turn 40 and realize you have not saved anything for retirement? Do not panic! You can still catch up, but you may need to push on the accelerator a little bit.
Initially, you will need to start contributing as much as possible to your plan, starting at five percent and increasing it two percent each year until you reach the maximum allotted by your company. Additionally, it will help invest in more aggressive funds, like stock funds, subject to short-term volatility but have historically generated higher long-term returns.
HOW YOUR SAVINGS COULD GROW
For people who start saving at age 40 and save steadily until age 65, it is still possible to accumulate a significant nest egg. So whether you are fresh out of college, approaching retirement, or somewhere in between, the best time to take advantage of your employer retirement plan is now!
How to catch up for starting late saving for retirement
Some people take more significant risks in the attempt to get bigger returns. But there is a more straightforward, more prudent way.
Many reasons explain why older Americans are financially ill-prepared for retirement.
Many people did not make enough money to set aside for their later years. Others experienced bad luck in their careers, poor financial role models, unhealthy personal-finance habits, or had did not have the proper knowledge on good money management.
Many Americans place other spending priorities ahead of financial retirement. Statistics show that only 43 percent of American workers participate in a retirement savings plan. Many people regret they did not start saving younger in life, forfeiting the vast compounding benefits.
Another example of compounding interest is displayed when a 25-year-old puts $10,000 in a stock index fund and only adds $500 a month until age 65; he or she would get $2.34 million. Thus, the 9 percent long-term historical average annual gain for U.S. stocks would compound over four decades, with only a total of $250,000 investment.
Late starting investors can take riskier approaches in their investment portfolios by looking at technology stocks — taking you to your goal quicker. However, focusing on saving rather than investing as you get older may be the more prudent and practical choice.
As mentioned earlier, compounding investment returns over long periods is a surefire way to retire comfortably. Another example can be displayed by assuming you begin saving $500 a month at age 25 and stop saving at age 35. That is a ($60,000 initial investment). With a 7 percent annual return, you will end up with $720,000 at the age of 65 if you began saving that same amount at the age of 40 and kept saving until 65. That is a ($150,000 initial investment). With a 7 percent annual return, you would net $412,000. So, you can see the benefits of compounding interest. While beginning the saving for retirement process in your 40s or 50s is not ideal, and it is not a lost cause either.
If you are starting late on your retirement plan, you can take steps to fund your post-working years. However, you must first stop wasting time and make some potentially uncomfortable moves. The best time to start saving was about ten years ago, but at least you are starting today. Do not be depressed if you are in a place of feeling behind. Many people in the same situation will give up, saying it is too late, but that is not the case. You just must create a plan that works for you.
What’s Possible? Create a Plan to Find Out!
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Older savers have potential advantages. They are in the peak years of earnings, where their kids are out of the house and off their parental support. This, in return, provides extra money to route into savings. There is even more money to be rerouted into savings for those who have paid their mortgages off. Fortunately, the government recently, as of 2020, offers catch-up provisions to employees over the age of 50 — an extra $6,500 in a 401(k) and an additional $1,000 in an IRA over the standard contribution limits.
You might be tempted to take a ton of risks with your investments to catch up. However, saving money is still far more important than how you invest 10 to 20 years before retirement.
Saving vs. Investing
Let’s show an example of savings vs. investing. Assume Jack and Jill Smith are 50 years old, with little retirement savings. However, the kids are grown to supercharge their savings to make up for lost time. Jack wants to take on more risk to catch up, while Jill would instead simply save more.
The Smiths have a household income of $100,000, which will increase at a 2 percent cost-of-living adjustment each year. Jill expects their investments to compound at 6 percent annually and would like to save 20 percent of their income. Jack thinks he can do much better than that by trading stocks and saving a little less. Jill thinks Jack is too optimistic. For the average investor, trading stocks usually a money-losing proposition. A University of California study shows that active traders massively underperformed in index funding, thus showing that people who traded the most also had the worst returns.
Since the Smiths want to retire between the ages of 65 to 70, they are unsure how far their savings will go in such a short time. Here is an example of their current plan, one with a higher savings rate and one where Jack’s stock picks perform at a high rate:
Even if Jack doubled Jill’s six percent return target, a higher savings rate would have led to better results. A doubling of the Smith’s savings rate from 10 percent to 20 percent producing a better outcome than a doubling of their investment return over two decades. So, increasing your savings rate is way easier than increasing investment returns.
A balanced approach
Many people who begin to save late in life assume that all their assets need to be placed into the stock market to make up for lost time. However, your portfolio needs to be balanced with real estate, bonds, and cash with an ample savings rate.
Taking on more stock market risk does not guarantee better results. The market will not give you profitable returns just because you need them. Your savings rate is something that you control, while no one controls the returns thrown off by the financial markets.
Saving at an early age is essential due to forming solid financial habits and causes compound interest to snowball your money over time. But saving is probably even more critical for those who are behind on their retirement savings. This is because you do not have as long to allow compounding interest to do its thing.
Now, this does not mean your time as an investor has ended when you retire. The Social Security Administration states that a couple who retires today will have a 50 percent chance of living into their 90s. So, you could still have two to three decades to manage your money during post-work years. It is just that your time as an earner and saver may have a shorter shelf life if you do not work during retirement.
Working longer will allow you to save more money and let compounding interest do its thing, lowering the number of years your portfolio needs to last during retirement and potentially delaying taking Social Security payments. For example, delaying Social Security benefits from age 62 to age 70 can increase your monthly benefit by more than 70 percent. Of course, not everyone wants to work longer, but it can drastically increase your odds of success in retirement for those willing and able.