While many of us have altruistic notions about what, exactly, we work for, let's not kid ourselves. One very important aspect of a career is the money that it earns us.
Not all of us are working only to accumulate sufficient funds for an eventual retirement, but that's certainly a sweetener of the whole “employment” deal. And if that's one very important component of our employment, then why do so many folks haphazardly choose their investments and never change them over the vast majority of their working lives, while others avoid contributing to their company retirement plans altogether?
It is no simple task to save and invest properly to fund your retirement years; however, remembering some important rules and adhering to a simple guideline or two may make the difference between early retirement and no retirement at all. Let's take a closer look at a few key components of a well-executed retirement savings strategy.
Compounding growth in an investment account is the primary rationale behind the guidance to start saving earlier in life, and it is the multiplying effect of compounding growth that underscores the true benefit of most retirement savings strategies.
Think about it: $100 invested at a hypothetical 7 percent return would yield $107 after the first year, but the growth that those funds achieve by the end of the second investment year begins to highlight the benefits of compounding. At the end of year two, rather than simply having $114, the $7 that was earned by the end of year one will also grow at a 7 percent rate, thus yielding $114.49.
No, that 49 cents isn't going to make the difference between a monthlong trip to Hawaii in retirement and a meager staycation, but consider the long-term effect of compounding and you can begin to understand its true impact.
Given 30 years to grow at an annualized 7 percent rate of return, your $100 will have grown to $761, but absent compounding growth (i.e., just simple growth, which is the same as adding $7 to a $100 account for each year that it is invested) that $100 would have grown to merely $310.
The sum of money earned due to compounding growth is greater than twice the sum earned without the benefit of compounding.
Many retirement accounts benefit disciplined savers by offering the opportunity for tax-deferred growth over many years, and so I often encourage many of my clients to “max out” their savings in these types of accounts.
In our previous example, the compounding growth of $100 over 30 years worked best because retirement savings aren't taxed annually. If we were instead to assume that the 7 percent earned annually were subject to a 30 percent income tax rate, that $761 sum at the end of 30 years would have been diminished significantly, yielding only $410, because a full $351 was lost to taxation over the years.
The annual savings limits into many retirement accounts change every few years and oftentimes those limits are contingent on other factors like income or marriage, so you'll certainly want to consult your financial planner and accounting professionals while planning your annual savings into these types of accounts. Still, it stands as generally reasonable guidance to consider socking away as much as possible into these types of accounts in order to get the maximum benefit of tax deferral.
Dollar-cost averaging is an easily overlooked benefit of consistent and regular investment into volatile markets, and this may be because it happens automatically when saving regularly into a 401(k) or other similar employer sponsored retirement plans.
While the inner workings of this tenet of investing tend toward the wonkish, the concept can be stated simply. One acquires shares of an investment by investing a fixed dollar amount at a regularly scheduled interval over time (e.g., biweekly or monthly savings into a 401(k) plan). When share prices are high, your dollars will purchase fewer of them, but when share prices are low, your dollars will go much further, purchasing you more shares. Historically, this would have resulted in a lower average price per share than you would get when buying a fixed number of shares at each investment interval.
Dollar-cost averaging just means that you'll be spending less for more, and if you're going to price shop everything else in your shopping cart, your retirement investments should be no different.
Anthony M. Conte is managing partner at Conte Wealth Advisors with offices in Camp Hill and Fort Myers, Fla. He has a master's degree in financial services and the certified financial planner certification. Email him at firstname.lastname@example.org.
Registered representative securities offered through Cambridge Investment Research Inc., a broker/dealer, member FINRA/SIPC. Investment advisor representative Cambridge Investment Research Advisors Inc., a registered investment advisor. Cambridge and Conte Wealth Advisors LLC are not affiliated.