YOU MAY BE SAVING and investing for retirement. But what you’re really doing is buying future income. How much income? That brings us to a little number crunching, which I hope will illuminate five key financial ideas.
Let’s start with the numbers. Imagine stocks notch 6% a year, but inflation steals two percentage points of that gain, so you collect an after-inflation annual return of 4%. If you socked away $1,000, what would it be worth in retirement? We’ll look at the value as of age 70—and not just the sum accumulated, but also how much income it would generate each year thereafter, assuming a 4% portfolio withdrawal rate.
There’s nothing especially sophisticated about these examples. But I hope they highlight five important financial lessons. First, by not spending today, we can potentially spend far more in future.
Second, time is the lever that turns modest sums into great wealth. The earlier we start, the better off we’ll be.
Third, we don’t save and invest today simply to pile up the dollars. Rather, we save today so we can spend later (and, if we don’t, our heirs will happily take on the task).
Fourth, impressive wealth seems less impressive when we ponder the lifestyle it can support. Make no mistake: It takes a hefty nest egg to pay for a comfortable retirement.
Finally, inflation is the mortal enemy of the long-term investor—and stocks are the great ally. The numbers above may seem a tad disappointing, once inflation is factored in. But imagine how much worse they’d be if we assumed not stock market returns, but those generated by savings accounts and money market funds.
In addition to inflation, long-term investors need to fend off the threat from taxes and investment costs. What to do? That’s easy: Shovel your dollars into tax-deductible and Roth retirement accounts—and use those accounts to buy low-cost index funds that give broad market exposure.