Sara Teasdale once said: “When I can look life in the eyes, grown calm and very coldly wise, life will have given me the truth, and taken in exchange – my youth.” And the exchange can often be uneven and unwanted. If you have heard this one before: start putting money in your 401(k) plan early, and you didn’t heed that advice, you have been given the truth by the bucketful.
The concept of starting early, preferably in your twenties is part of the overused mantra of those who have shifted the blame of “not having enough to retire on” to the person who failed to take advantage of this once-in-a-lifetime opportunity. If you attended college, in all likelihood, you exited with a pile of student loans that are at once unmanageable and regrettable. How, the youthful investor asks, can I live on my own, pay my student loans, and find enough to invest for my future four to five decades removed? It is often this order in which they place their lives after graduation. Freedom, working on freeing themselves from the shackles of paying for that freedom, and misunderstanding the freedom that early investing returns.
We waste the following examples on the youth: If you begin in your twenties and put away $5,000 a year, every year, faithfully until you retire, you will have a 401(k) worth in the neighborhood of about $700,000. Of course this also relies on a steady growth in the markets of at least 5%. Miss that initial decade and you could halve your chances at reaching that amount.
Since the vast majority of us missed that decade, how much more would we need to get it back? It is important to understand, this “invest in your twenties” adds the miracle of compounding to the mix. It allows markets to correct even as you are afforded more risky investments. What goes up in other words, really goes up and when it goes down, it doesn’t fall as a far.
Older folks on the other hand, witness direct changes to their invested dollars when markets recede making the pain even more real. As the recent market downturn proved, the average investor had about two-thirds of their own money in their plan. Losing more than 33% of your account’s value wiped out not only all of your gains, but also ate into the money you worked so hard to invest.
To make up the shortfall, sage advisers suggest that you invest more (raises, bonuses, etc. as soon as you get them), that you gradually increase your contribution to make up for those “missing years” and that you never let up. In works in theory of course and on any retirement calculator you might use. But in practice, you have to adjust to living with far less now to ensure you don’t live on far less in the future.
Retirement is relatively easy to calculate. No, I’m not going to give you a percentage or even an exact figure because in large part, we don’t know enough about the future to even make the call. taxes could be higher. Inflation could be running rampant. And your health may not be as robust as it is now.
The easy calculation works like this: take all of your current obligations – your mortgage, your bills (including groceries and utilities) and your cost of living (insurances on cars, the cost of the cars, the cost of kids and parents, the cost of upkeep on all of your stuff, and the cost of keeping yourself entertained – cable, internet, golf, vacations) – and add them up. It should be relatively easy since you already have a budget (if not, go here). Now eliminate a third of your income. Can you continue to live?
We sent ourselves up for failure in the most subtle of ways. Yet we can fix those failures with some subtle tweaking. Most of what I mentioned above is life with a price and we are, in many instances, unable to adjust those costs. In fact, those costs will increase by 2% (at least) each year over the current calculation. A fixed mortgage jumps with taxes and insurances, your bills aren’t getting any less expensive and your cost of living is not likely to get less expensive as you age.
All that is left is your ability to invest more. How much more? If a twenty year old can expect to be greeted with $700k at retirement (on $5,000 a year at 5% growth), what should you expect to have if you invested the same amount? You, beginning in your thirties will expect about 35% less. You will need to increase you annual contribution by 35% just to break even.
Retirement calculators are quite possibly the worst invention ever. No two give you the same number, the same goal or the offer to input the same information. What they do succeed in doing is creating a feeling of hopelessness, fear and anxiety. And like any warm-blooded mammal, we recoil from pain. And do nothing.
So before you begin to simply ignore the warning signs and plow ahead on the road of life, consider increasing your contribution while at the same time finding ways to trim your expenses. Unsecured debt can free up an awful lot of investable cash; so eliminating those debts and channeling that found income into your retirement accounts is like found money. It is a simple first and almost painless step but a very good one to take.
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