Let's say your retirement savings have been pummeled in the last couple of years. You've lost faith in the stock market, and haven't jumped back in notwithstanding this year's rally. You're in good company, as numerous long term investors (such as individuals saving for retirement) haven't taken the bait on the current bull market, or bear market rally, or whatever it will turn out to be with the benefit of hindsight. They prefer to avoid loss, and given recent history, that's not a bad strategy.
But we still have the question of what to do financially about the future. Bear in mind the simple power of compounding. Compounding comes about when you save and reinvest the income from your savings. It is particularly effective when you add to your savings regularly, like every pay day. Look at the following example.
Assume you're 15 years away from retirement and you can barely bring yourself to look at your 401(k) account statements. In the past you weren't so committed to building the account and you now have a recession-diminished balance of $100,000. You understand that, more than ever, you're responsible for making your retirement years golden. You resolve that you're not going to have dog food as part of your diet in old age, and seriously rearrange your financial priorities so that you can contribute the maximum amount permitted by IRS regulations to your 401(k), currently $16,500 a year. You've had it with the stock market and decide to stick to high quality bonds. We'll assume you can earn an average return of 4% per year on your all-bond portfolio. At the end of the remaining 15 years of your working life, your 401(k) account will have a balance of approximately $510,000. If we assume that inflation runs at its historic average of 3% per year, your inflation adjusted balance will be about $323,000.
In other words, if you buckle down now and max out your 401(k) for the rest of your career, you can give your retirement account balance a very large boost, even with modest returns and adjustment for inflation. This is what compounding does. By saving more each pay day and reinvesting your returns, you can leverage up your retirement savings dramatically.
Most of the financial advice you see on the Internet and in other news media focus on an endless array of investments, strategies, choices and decisions. But much and perhaps most of the mileage you can get from your capital comes from compounding. Your choice of investment strategies and the allocation of your portfolio may give you greater or lesser potential profits, at the risk of greater or lesser volatility. But the discipline of saving on a compounded basis is the foundation on which everything else rests. If you love compounding, compounding will love you.
Showing posts with label love. Show all posts
Showing posts with label love. Show all posts
Tuesday, September 29, 2009
Wednesday, May 16, 2007
How to Retire Without Saving
Many people can't save. Sometimes it's for good reasons--illness, an aged parent who needs support, a child with special needs, or too low an income. Other times, the reasons are not so good--serial spending, reckless investing or indifference to the future. Whatever the reasons, good or bad, these people need to retire, too. How can they do it? Here are some ideas.
1. Get a job with a pension. Government jobs, military service, law enforcement and educational jobs usually offer pensions. Some of these employers also offer retirement savings accounts similar to the 401(k) plan--the federal government's Thrift Savings Plan is an example. These jobs aren't for everyone. Governments are often bureaucratic, and action-oriented people may have a hard time fitting in. Teachers sometimes find that their jobs involve as much babysitting as teaching. Military and law enforcement personnel perform yeoman's duty for everyone else, but they have to be disciplined, motivated and able to deal with a highly structured and high-pressured environment. It often takes 20 or more years to qualify for a pension, so this isn't a cakewalk. But if you think you're cut out for one of these jobs, and your retirement savings hover around zero on a good day, give it a try.
Corporate pensions continue to exist, especially at the larger, old line companies. But most corporations are fleeing the traditional defined benefit pension (the good kind) faster than rich folks left New Orleans before Katrina. New hires often are unable to participate in the older pension plans. If you have the opportunity to participate in a corporate pension plan, consider yourself lucky. But don't rely entirely on the company pension. You may be disappointed.
2. Buy a house and pay off the mortgage and all home equity debt. Many people who can't put $20 into a savings account always manage to pay the mortgage one way or another. The house can be used as a vehicle for forced savings. Just don't mess things up by taking out a home equity loan or home equity line of credit. You'll get only a finite amount of home equity in your life. If you take out home equity debt, you use up some of your finite lifetime home equity. Yes, you can repay the home equity loan, but you have to use cash that could otherwise have been devoted to retirement savings. If you enter retirement with a home that's free and clear of all liens, you'll have a valuable asset that could add much to your golden years.
3. Work longer. The longer you work, the more your Social Security payments will be. We explained how this works in our earlier blog, Mysteries of Social Security Retirement Benefits, Part 1 (blogger.uncleleosden.com/2007/05/mysteries-of-social-security-retirement.html). An added benefit of working longer is that it gives you more time to save, and, if you are lucky enough to have a pension, it may help you earn a larger pension. While working longer isn't the fastest way to the cabana on the beach, you may end up with a nicer cabana.
4. Stay together. This is something we discussed in our blog "Love in a Time of Financial Planning--Part Deux" (blogger.uncleleosden.com/2007/04/love-in-time-of-financial-planning-part_20.html). Two people together can often do better than if they were alone. Consider the following example. Each member of a couple gets $15,000 in Social Security benefits, and has $250,000 in savings, enough to allow withdrawal of $10,000 a year in retirement beginning at age 65. Individually, they'd each have $25,000 a year, enough to be okay, but not more than that. Together, they'd have $50,000 a year, enough to be solidly middle class. The idea of staying together for financial reasons conjures up images of bedraggled housewives stuck in loveless marriages with unshaven, potbellied louts who drink too much and smoke cheap cigars. That's not what we mean. Sometimes, no relationship is better than a bad one. But you have many reasons to make your relationship work and your financial well-being may be one of them.
None of these strategies will get you luxuries. You need savings for that. But if you feel like you're financially lost, don't give up. There's still hope for you.
Strange News: Trying to make fast food faster--www.nbc4.com/news/13326368/detail.html?dl=headlineclick.
1. Get a job with a pension. Government jobs, military service, law enforcement and educational jobs usually offer pensions. Some of these employers also offer retirement savings accounts similar to the 401(k) plan--the federal government's Thrift Savings Plan is an example. These jobs aren't for everyone. Governments are often bureaucratic, and action-oriented people may have a hard time fitting in. Teachers sometimes find that their jobs involve as much babysitting as teaching. Military and law enforcement personnel perform yeoman's duty for everyone else, but they have to be disciplined, motivated and able to deal with a highly structured and high-pressured environment. It often takes 20 or more years to qualify for a pension, so this isn't a cakewalk. But if you think you're cut out for one of these jobs, and your retirement savings hover around zero on a good day, give it a try.
Corporate pensions continue to exist, especially at the larger, old line companies. But most corporations are fleeing the traditional defined benefit pension (the good kind) faster than rich folks left New Orleans before Katrina. New hires often are unable to participate in the older pension plans. If you have the opportunity to participate in a corporate pension plan, consider yourself lucky. But don't rely entirely on the company pension. You may be disappointed.
2. Buy a house and pay off the mortgage and all home equity debt. Many people who can't put $20 into a savings account always manage to pay the mortgage one way or another. The house can be used as a vehicle for forced savings. Just don't mess things up by taking out a home equity loan or home equity line of credit. You'll get only a finite amount of home equity in your life. If you take out home equity debt, you use up some of your finite lifetime home equity. Yes, you can repay the home equity loan, but you have to use cash that could otherwise have been devoted to retirement savings. If you enter retirement with a home that's free and clear of all liens, you'll have a valuable asset that could add much to your golden years.
3. Work longer. The longer you work, the more your Social Security payments will be. We explained how this works in our earlier blog, Mysteries of Social Security Retirement Benefits, Part 1 (blogger.uncleleosden.com/2007/05/mysteries-of-social-security-retirement.html). An added benefit of working longer is that it gives you more time to save, and, if you are lucky enough to have a pension, it may help you earn a larger pension. While working longer isn't the fastest way to the cabana on the beach, you may end up with a nicer cabana.
4. Stay together. This is something we discussed in our blog "Love in a Time of Financial Planning--Part Deux" (blogger.uncleleosden.com/2007/04/love-in-time-of-financial-planning-part_20.html). Two people together can often do better than if they were alone. Consider the following example. Each member of a couple gets $15,000 in Social Security benefits, and has $250,000 in savings, enough to allow withdrawal of $10,000 a year in retirement beginning at age 65. Individually, they'd each have $25,000 a year, enough to be okay, but not more than that. Together, they'd have $50,000 a year, enough to be solidly middle class. The idea of staying together for financial reasons conjures up images of bedraggled housewives stuck in loveless marriages with unshaven, potbellied louts who drink too much and smoke cheap cigars. That's not what we mean. Sometimes, no relationship is better than a bad one. But you have many reasons to make your relationship work and your financial well-being may be one of them.
None of these strategies will get you luxuries. You need savings for that. But if you feel like you're financially lost, don't give up. There's still hope for you.
Strange News: Trying to make fast food faster--www.nbc4.com/news/13326368/detail.html?dl=headlineclick.
Friday, April 20, 2007
Love in a Time of Financial Planning, Part Deux
In our preceding blog, we explained the value of compounding your investment returns to make your net worth grow in ever-increasing amounts. We pointed out that if you love compounding, compounding will love you. In this blog, we will discuss another aspect of love in the world of financial planning: namely, love.
If you stay together with your significant other, the two of you will have much more financial strength than you'd have separately. Very few people have storybook lives, in which they work for 40 years straight with ever rising incomes and then collect the gold retirement watch on their way to a Gold Coast penthouse apartment. Most people have ups and downs, periods of employment and periods of unemployment. During their working years, two people together can support and help each other. If one becomes unemployed or ill, the other can support the household until the first recovers and resumes working. As the two of them of ride through the ups and downs of life together, they stay on a much more even financial keel than they would separately.
The same remains true in retirement. Consider this example: each of you is eligible to collect $15,000 from Social Security and has $250,000 saved up in retirement and other accounts. We'll assume that neither of you has a pension (which is increasingly the case). A conventional financial rule of thumb is that, if you retire around 65 and want to make your savings last for the remainder of your life, you can spend 4% of your savings per year, adjusting annually for inflation. Thus, each of you would be able to withdraw $10,000 from your savings the first year of your retirement. Add that to your $15,000 from Social Security and you'd have $25,000 apiece. If you're living alone, that's enough to be okay, but not more. If you are together, you'd have a combined income of $50,000, enough to be solidly middle class (except maybe in a few high cost cities on the East and West Coasts).
The idea of staying together for financial reasons conjures up images from yesteryear of bedraggled housewives economically locked into loveless marriages with slovenly loutish pigs who never tucked in their shirts, drank cheap beer by the case, watched TV all day, filled their homes with the acrid smoke of nickel cigars, and demanded to be served from dawn til dusk. That's not what we're talking about. In some instances, no relationship is better than a bad relationship, regardless of the financial impact. And a relationship based only on money isn't likely to last. But you have a lot of reasons to make your special relationship work, and increased financial strength is one of them. Much of love involves sharing and giving, and love in a time of financial planning benefits both of you.
If you stay together with your significant other, the two of you will have much more financial strength than you'd have separately. Very few people have storybook lives, in which they work for 40 years straight with ever rising incomes and then collect the gold retirement watch on their way to a Gold Coast penthouse apartment. Most people have ups and downs, periods of employment and periods of unemployment. During their working years, two people together can support and help each other. If one becomes unemployed or ill, the other can support the household until the first recovers and resumes working. As the two of them of ride through the ups and downs of life together, they stay on a much more even financial keel than they would separately.
The same remains true in retirement. Consider this example: each of you is eligible to collect $15,000 from Social Security and has $250,000 saved up in retirement and other accounts. We'll assume that neither of you has a pension (which is increasingly the case). A conventional financial rule of thumb is that, if you retire around 65 and want to make your savings last for the remainder of your life, you can spend 4% of your savings per year, adjusting annually for inflation. Thus, each of you would be able to withdraw $10,000 from your savings the first year of your retirement. Add that to your $15,000 from Social Security and you'd have $25,000 apiece. If you're living alone, that's enough to be okay, but not more. If you are together, you'd have a combined income of $50,000, enough to be solidly middle class (except maybe in a few high cost cities on the East and West Coasts).
The idea of staying together for financial reasons conjures up images from yesteryear of bedraggled housewives economically locked into loveless marriages with slovenly loutish pigs who never tucked in their shirts, drank cheap beer by the case, watched TV all day, filled their homes with the acrid smoke of nickel cigars, and demanded to be served from dawn til dusk. That's not what we're talking about. In some instances, no relationship is better than a bad relationship, regardless of the financial impact. And a relationship based only on money isn't likely to last. But you have a lot of reasons to make your special relationship work, and increased financial strength is one of them. Much of love involves sharing and giving, and love in a time of financial planning benefits both of you.
Thursday, April 19, 2007
Love in a Time of Financial Planning, Part 1
We're not talking about a decades-long romance. We're talking about a decades-long process in financial planning that is crucial to understand. Because it involves a lot of money--and we mean a lot--it's something you would grow to love as you learn more about it. We're talking about the compounding of investment returns.
Compounding of investment returns simply means reinvesting the interest, dividends, capital gains and other profits from an investment. For example, assume you have $10,000 invested and receive a 5% gain each year, or $500. If you spend the $500 on lifestyle enhancement, your return every year will remain $500. But if you reinvest the the $500, look at what happens: (a) in year 2 of the investment, you'll have $10,500 invested (i.e., the original $10,000 plus the $500 return for year 1), which yields a return of $525; (b) in year 3, you'll have $11,025 invested ($10,500 from year 2, plus the reinvested $525 return from that year), which yields a return of $551.25; and (c) in year 4, you'll have $11,576.25 invested ($11,025 from year 3, plus the reinvested $551.25 return from that year), which yields a return of $578.81. As you can see, the process of compounding increases both your invested total and each year's returns. Over time, they grow by ever-increasing amounts. That's the heart of the process of compounding: you'll get more over time, which will help you get even more in the future. In other words, the more you love compounding, the more compounding will love you.
If this investment compounds for 30 years, it will reach a total of about $43,000. If it compounds for 40 years, it will reach a total of about $70,000. If you don't compound, the investment will remain at $10,000. That doesn't build wealth.
Compounding allows you to plant a money seed and watch it grow over time. Even a relatively small seed like $10,000 grows to $70,000 in the example above (which assumes a modest 5% annual rate of return). There is the question of inflation. Assuming that inflation stays at its long term historical rate of approximately 3% per year, the $70,000 will be worth about $20,000 in today's dollars. Not impressive, you think. But consider what happens if you don't compound: the original $10,000 becomes equivalent to about $3,000. Whatever inflation does to compounding, its effect is far worse if you don't compound.
Compounding is one of the most powerful tools an investor has, and it's available to everyone. You don't have to have an MBA or be a favored customer of a Wall Street firm to be able to compound. Anyone who saves and invests can compound. Any time you put some money in a bank account, money market fund, or mutual fund, make sure you reinvest the interest, dividends and other gains. Remember, if you love compounding, compounding will love you.
Our next blog will continue the discussion of love in a time of financial planning.
Compounding of investment returns simply means reinvesting the interest, dividends, capital gains and other profits from an investment. For example, assume you have $10,000 invested and receive a 5% gain each year, or $500. If you spend the $500 on lifestyle enhancement, your return every year will remain $500. But if you reinvest the the $500, look at what happens: (a) in year 2 of the investment, you'll have $10,500 invested (i.e., the original $10,000 plus the $500 return for year 1), which yields a return of $525; (b) in year 3, you'll have $11,025 invested ($10,500 from year 2, plus the reinvested $525 return from that year), which yields a return of $551.25; and (c) in year 4, you'll have $11,576.25 invested ($11,025 from year 3, plus the reinvested $551.25 return from that year), which yields a return of $578.81. As you can see, the process of compounding increases both your invested total and each year's returns. Over time, they grow by ever-increasing amounts. That's the heart of the process of compounding: you'll get more over time, which will help you get even more in the future. In other words, the more you love compounding, the more compounding will love you.
If this investment compounds for 30 years, it will reach a total of about $43,000. If it compounds for 40 years, it will reach a total of about $70,000. If you don't compound, the investment will remain at $10,000. That doesn't build wealth.
Compounding allows you to plant a money seed and watch it grow over time. Even a relatively small seed like $10,000 grows to $70,000 in the example above (which assumes a modest 5% annual rate of return). There is the question of inflation. Assuming that inflation stays at its long term historical rate of approximately 3% per year, the $70,000 will be worth about $20,000 in today's dollars. Not impressive, you think. But consider what happens if you don't compound: the original $10,000 becomes equivalent to about $3,000. Whatever inflation does to compounding, its effect is far worse if you don't compound.
Compounding is one of the most powerful tools an investor has, and it's available to everyone. You don't have to have an MBA or be a favored customer of a Wall Street firm to be able to compound. Anyone who saves and invests can compound. Any time you put some money in a bank account, money market fund, or mutual fund, make sure you reinvest the interest, dividends and other gains. Remember, if you love compounding, compounding will love you.
Our next blog will continue the discussion of love in a time of financial planning.
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