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I posed this question to an AI program (because I don’t know how to use a spreadsheet).
“If my income is $3,000 per month, I save 10%, I expect to earn 8% per year on invested money and my income will increase by 2.5% per year (basically inflation). How much will I have in 40 years?”
Here’s the answer.
You’d have about $1.29 million after 40 years, assuming you invest the savings monthly, earn 8% per year compounded monthly, and your income — and therefore your 10% savings amount — rises 2.5% each year. Assuming all tax deferred.
About $914,000 of the final $1.29 million is growth from returns on your investments
If you save only 5% of income instead of 10%, you’d have about $645,600 after 40 years
About $457,000 of the final $645,600 is growth from returns on your investments.
Compounding is pretty powerful stuff. Imagine if this was all in a Roth account. Saving a portion pre-tax will help with take-home pay.
Add a few extra dollars along the way; tax refund, a bonus, a gift, whatever and things look better.
In my opinion, for most people this is very doable and once in place will continue virtually unnoticed. Lifestyle with a bit of discipline will be based on net income. Add Social Security to this nest egg and retirement should be comfortable.
We could play with the numbers all we like, but the approach is sound for most people even recognizing life’s blips along the way.
Out of curiosity, are these figures real or nominal?
They are as real as any long term estimates with assumptions can be. If one assumption is off over 40 years they are wrong. Just like a budget or planning spreadsheet 🤑
Do you know what the weird thing is? I’m just about to post a piece around compounding. But mine’s from the past until now, rather than from now into the future! 😁
Nominal returns are not adjusted for inflation. Real returns are, and as such are much more useful for planning purposes.
A year or so ago, I analyzed whether or not I could have done better than Social Security if I had been able to invest my payroll taxes in the S&P. The simple answer was yes, but the real (and more accurate) answer was much more complicated. What if I had become disabled, what if I died leaving behind a wife and a housefull of kids, what about spousal and survivor benefits? Finally, the question most pertinent to both my and your post is if it’s realistic to expect (most) people to follow through with saving over a period of 40 years. The math is simple and correct, the reality, sadly, is not.
Ah there is the rub. Everything works perfectly and you may well accumulate in assets an amount to generate higher income than SS provides. But working exactly as planned for forty years or so is highly unlikely.
Plus, the mistake people make is thinking of SS as retirement income for the worker. It’s not that, it is insurance for all the things you mention and more. There are children disabled from birth ex-spouses concurrently with current spouses and the big one, spousal benefits for non working spouses.