Saturday, May 10, 2008

Retirement 101: The early bird gets the nest egg

I spent last summer with the Center for European Economic Research. During this time, I had a revelation: America is headed for a horrific retirement crisis, unlike anything we’ve ever seen. The recipe for disaster is quite simple: Americans are not saving, the cost of health care is rising, pension plans are disappearing, Social Security is nearly dead, and people are living longer than ever before. A longer life only prolongs the misery of that life if you have not saved and prepared for your future.

I talk to college students all the time about saving for retirement, and I am sure that about 1/3 of them listen. I didn’t listen when I was in college, but I wish I had. If I had done so, I would know about the Financial Magic that takes place when you save and invest in the stock market over a long period of time. I’m not talking Harry Potter, but the Pot of Gold at the end can make your life as rich as a Hollywood block buster.

Let’s do the math: Assume that Angela starts saving for retirement at 45, Danny starts at 35, and Cindy starts at 25. All of them save till they are 65, each investing in the stock market, earning an average return of 10% per year. Angela earns the most on her job ($55,000) since she is the oldest, with Danny coming in second ($45,000) and Cindy coming in third ($35,000). But when Cindy is 35 and 45, she will earn the same amount as her older counterparts. Based on this assumption, all of them earn the same amount over their lifetimes. I won’t adjust for inflation, since this has been enough to absorb already (isn’t math annoying sometimes?).

Assume Angela, Danny and Cindy each save a measly 10% of their pay before taxes and have that money put into a retirement account that invests in a diversified portfolio in the stock market. By diversified, I mean that they don’t buy just one stock, they have their money spread out over a lot of stocks and all their eggs are not in one basket.

Let’s figure out the size of their nest eggs, shall we? Drum roll please: Angela, who got off to a late start, will have $348,041.50 in her retirement account, minus taxes paid when she withdraws the funds. Not good, not bad. It’s better than nothing.

Danny is better off. By saving 10% of his income when he earns $45,000 and then continuing to save when his pay rises to the level of Angela’s, Danny ends up with $864,826, more than twice as much as Angela. Good for Danny, he can afford to maintain his golf and cheeseburger habit.

Cindy is the smart one. Fresh out of college, she doesn’t spend all of her money at the club. Instead, she spends some of it planning for her financial future. Starting at 25 instead of waiting, how much doe Cindy have at retirement? A cool $1,907,340.54. You go girl. Instead of saving just 10% of her income, she may save 20%, which would effectively double this amount to $3.8 million dollars. Now, that’s Financial Magic at its best. Harry Potter has nothing on Cindy.

What’s my point? The point is obviously not for you to obsess over the tiny variations in numbers. My point is that by planning ahead, you can get ahead. If you are planning behind, then you’ll always stay there. Start saving early if you can, and if you can’t start early, then get started TODAY!

Dr. Boyce Watkins is a Finance Professor at Syracuse University and author of “Financial Lovemaking 101: Merging assets with your partner in ways that feel good”. He provides regular commentary in national media, including CNN, FOX, BET and CBS.

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