Tuesday, July 08, 2008

Power of Saving

Everyone knows the saying, "It takes money to make money." But how much does it take? It's easy to assume it takes, well, more than we have. Believe it or not, though, the headlines you occasionally come across that say "Minimum-Wage Worker Retires Millionaire" are true.

The secret? Compound interest. The method? Work, discipline, and saving.

If you're earning a minimum-wage salary of $5.85 per hour (or $12,168 per year), and you start saving and investing 10% -- the recommended portion -- at age 20, you'll retire at 67 with $1.2 million. $57,152 in savings turns into $1.2 million. That's the magic of compound interest.

Now compare that return with simply putting your nest egg into an average savings account:


Savings Account Return (3%)

S&P 500 Annualized Return (10%)















$1.56 million

Source: MoneyChimp calculator. For purposes of this illustration I have taken the S&P 500 historical annual return of 10%.

Granted, in 50 years, $1.56 million won't have the purchasing power it has today, but it will still add significant comfort to your retirement lifestyle. And if you earn more than minimum wage -- or if the minimum wage itself is raised -- that figure will be higher.

But what if you don't have 47 years to invest? However many -- or few -- years you have until retirement, the best time to start is always now.

Our retirements are less secure than ever. The future of Social Security is uncertain, and company pension plans are becoming underfunded or vanishing altogether. If you want to retire a millionaire in the future, it's up to you -- and the less time you have, the more you need to contribute annually.

Robert Brokamp, advisor of the Fool's Rule Your Retirement service, says that to secure a comfortable retirement, folks should crunch the numbers and get a plan -- now. Some of Roberts' tips include:

  • Calculate. Start by determining how much you need to save. Studies have shown that people who take the time to run their numbers are more likely to take action and improve their retirement prospects. As a rule of thumb, if you've saved less than $50,000, find ways to save more. The amount you save will have a bigger impact on your net worth than the return you receive on what you've saved.
  • Automate. Put your plan on autopilot by setting up automatic deductions from your paycheck to your retirement plan. You can also transfer money automatically to an IRA or brokerage account from your checking account. Discount brokerage firms like Sharebuilder allow you to set up automatic investments for about $4 a trade. This guarantees monthly contributions -- you'll be less likely to skimp on savings or skip a month.
  • Diversify. Improve your rate of return -- and minimize your risk -- by diversifying your nest egg. A well-diversified portfolio focuses on the whole, not the parts, and includes all five asset classes: U.S. large-cap stocks, U.S. small-cap stocks, international stocks, REITs, and commodities. If one asset takes a hit (like the housing market is currently doing), your risk is mitigated by the balance of the other four.

If, on that minimum-wage salary, you don't start saving and investing until you're 30, you'll earn less than half of that $1.2 million by the time you hit age 67! The amount you save, and the length of time you invest it, will have a substantial impact on your net worth -- whatever the market does over the long run. So run the numbers, put your plan into place, and be on your way to retirement security.

Investment tips: The easiest way to begin is with a low-cost, broad-market index fund such as the Vanguard 500 Index Fund (VFINX). With one investment, you'll be exposed to stocks that span the S&P 500, including well-known U.S. blue chips. For international stocks, you might consider an actively managed mutual fund like Dodge & Cox International (DODFX). This fund boasts a very impressive five-year annualized return of 22.8%, but it's also cheap (no loads, 0.65% expense ratio) and led by a talented management team.

Source: msn.fool.com

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