Spending Deferred

Jonathan Clements

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.

  • If your parents socked away $1,000 for you when you were born, you would have more than $59,000 at age 70, thanks to seven decades of 6% annual returns. But seven decades of inflation would also take their toll, so your $59,000 would be worth $15,572 in today’s dollars. That would generate $623 in annual income—again, figured in current dollars. That’s a pretty good tradeoff: In return for your parents’ onetime decision not to spend $1,000, you get to spend $623 every year in retirement, with money likely left over for your heirs.
  • If you put away $1,000 from your summer job at age 16, you’d have an inflation-adjusted $8,314 at age 70. You could then spend that lump sum or draw it down slowly using a 4% withdrawal rate, which would give you $333 in annual retirement income.
  • If you saved $1,000 when you entered the workforce at age 22, you’d have an inflation-adjusted $6,571 at age 70, which would then kick off $263 in income, assuming a 4% annual portfolio drawdown rate.
  • The $1,000 you save at age 40 would be worth $3,243 at 70, figured in today’s dollars. That should be good for $130 in annual income. Think of it this way: At $130 a year, you’d recoup your $1,000 sacrifice in less than eight years—and still have plenty of money left over to spend in subsequent years.
  • The $1,000 you salt away at age 50 would grow to an inflation-adjusted $2,191 at age 70, giving you $88 a year in retirement income.

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.

Follow Jonathan on Twitter @ClementsMoney and on Facebook.

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