A Primer on Retirement Saving (Part 1 of 5)

Save for Retirement?  C’mon, that is soooo far away.  This is the last thing on most people’s minds.  They want to travel, they want to buy nice clothes while they still look good in them, they want drink good beer.  I get it, I get it.  So do I.  But you need to realize that you are going to want to do all of these things when you retire and you need to have a way to pay for it!  So a little self sacrifice now will go a long way later.

 Let me use an analogy: Say Jim graduates from college and makes $40,000 a year.  His company offers a 401K plan and he decides to put away $4,000 annually.  His 401K returns an average of 9% per year for the next 43 years.  He does this until he retires at age 65 with $808,000* in the bank.

Aaron also makes $40,000 dollars per year.  He does not begin investing for retirement until he turns 40.  At this point he starts to sock away $8,000 per year in his employer’s 401K plan.  Like Jim his investments earn about 9% per year.  He does this until he retires at age 65 with $462,000* in the bank.

In terms of sheer dollars Jim saved $28,000 less than Aaron but he retires with $346,000 more than him. 

How did that happen?  Compound interest!  Compound interest is the concept that your interest earns interest and this makes you more money.

So moral of the story…Start saving early.  If I haven’t convinced you to start saving for retirement, well, don’t bother reading parts 2-5 of this series.  But please don’t cry to me when you are 85 and still working.  The most critical part of this whole process is to just do it – start planning for retirement early.

 In part 2 of this 5 part series “A Primer on Retirement Saving”, I will discuss the different investment vehicles you can use to save for retirement.  Stay tuned!

*adjusted for 3% inflation per year

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3 Responses to “A Primer on Retirement Saving (Part 1 of 5)”

  1. Mike Says:

    WOW. That is a great example of why you should start saving right away!

  2. James Says:

    As long as you’re adjusting for inflation on the return, I think you need to adjust for inflation on the contribution.

    Compounding is still a great thing, and Jim still comes out WAY ahead, but if you look at inflation-adjusted contributions, Jim actually saves MORE than Aaron. At 3%, Jim saves $98K in today’s money while Aaron “only” saves $84K in today’s money.

    If this sound fishy, think about what $4000 (or $8000) will buy in 43 years. (A loaf of bread if grandpa is right.) And, if the economy keeps up, how much that $8000 will “feel like” in 43 years as a portion of one’s income.

    I just wrote something up about this the other day — http://www.boiling-frogs.org/2007/09/19/apples-oranges/ .

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