Lessons on the Time Value of Money

A recent article by CNBC really brought home the time value of money and the impacts of rate of return on saving for retirement. Assuming an 8% rate of return, the monthly amount a person needed to save to have $1 million at age 65 changed dramatically with age:

  • Starting at 25 $284.55/month
  • Starting at 30 $433.06/month
  • Starting at 40 $1,044.53/month

I know some people will think those amounts are not obtainable, but $284.55 represents 10% of the monthly salary of someone making only $34,146 per year and that is before any employer match. If the employer matches contributions to a retirement plan, the required salary is even lower.

The amount also changed dramatically depending on the rate of return expected:

  • 8% return (starting at 25) $284.55/month
  • 6% return (starting at 25) $499.64/month
  • 4% return (starting at 25) $843.23/month

Some people tend to freak out when the stock market takes a downturn and we haven’t seen a sustained downturn since the last decade, but the numbers above show that you can’t put your money only in safe investments like bonds and treasuries. The return is not enough to get you where you need to go. And the younger you are, the more ability you will have to recover any losses because you are so long from retirement.

So, what does all this mean? While I agree with Dave Ramsey that doing smart things with money is 80% about behavior and only 20% about the math, and it is generally more important to change behavior through focusing on paying down debt first, if the debt can’t be paid off in a couple of years, the math can start to work against you in the worst way. Here are some very simple tips.

  • Start putting money away for retirement early; shoot for 10% of your salary. If you can’t get there right away, put in as much as you can and raise it every time you get a pay raise – you won’t miss what you never had.
  • Try hard to get your employer match, if available. You can count the employer match in getting to that magic 10% level (to get to that $1 million by age 65) and you won’t have 10% coming out of your check. Not getting the match is like telling your employer you really don’t want all your salary. Would any sane person really do that?
  • Don’t be too conservative in your investments – especially if you are young. Being too conservative is much more likely to reduce your chance of getting that $1 million than a periodic (and they will occur) market downturn.

As crazy as it sounds, there is no reason we could not have millions of millionaire millennials by the time they retire if they would just take notice of the time value of money. Talk about being able to change the world – wow!

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