An email from the Dave Ramsey site last week included a link to Useful Tools. I clicked it and went over to the Investing Calculator. I've seem similar calculators in the past and have run some numbers, but really didn't pay close attention or change my investment amounts or anything based on the results. Now that we've been following the principles of the Dave plan and have been more actively taking control of our financial future, the Investing Calculator had more meaning to me this time. Pull up the calculator and plug in the numbers I mention below to see the results for yourself.
As far as rate of return goes, Dave generally uses a rate of return over the long term of 12%, I tend to be a bit more conservative and I use a rate of 6% for purposes of this exercise. It's better to underestimate and end up with more money at retirement, then to overestimate your rate of return and end up with less money. If your rate of return does end up being 12% over the long term, great, you'll be in better shape than you figured initially.
I plugged in a generic value of 0 starting, 6% rate of return, $2000 a month and 30 years for the time frame. You end up contributing $720,000, your interest is basically $1.3 million which gives you a total of roughly $2.02 million dollars after 30 years. Not bad, however, if you keep everything the same and bump it up 5 more years to 35 years for the time frame, you end up contributing $840,000, total interest is $2.02 million for a total of $2.86 million. The same numbers, added in over 40 years results in a $960,000 contribution, $3 million in interest and a total of $4 million! Just having an additional 10 years worth of return and compounding interest results in a doubling of your retirement money from $2 million to $4 million! That should really hit home the importance of investing sooner rather than later.
Let's return to the first example and say you're a couple and are both 32 and want to retire when you are 62 and those numbers match what you will contribute and you're starting today. In 30 years, rounding down you'll have $2 million in your retirement account to pull from. Let's say you plan to live 30 additional years, to the age of 92. If you divide 2 million by the 30 years you plan to live, you get $66,667 per year. Keep in mind, the rest of your $ that you leave in there would continue to grow most likely, so it would probably end up being slightly more, but again, it's always good to be conservative with your numbers now and be pleasantly surprised when you have more than you expected when the time comes.
So, you have $66,667 to pull out per year for 30 years. Let's say you're both going to retire and no longer work when you hit 62 to keep it simple and we'll assume the bulk of that is in a 401k account. When you pull $ out of your 401k account, it will be taxed as regular income, so it would be as if you were both working and pulled in a combined salary of $66,667. Let's just very roughly say your tax bracket would be 25%. Taking out 25% for taxes, you would be left with $50,000 per year for 30 years. That would amount to $4,166 per month. To me, it seems like that $2 million dollars you had doesn't seem like all that much any more! It would of course depend on your personal situation. If you are living in a home that is paid for and are in good health, most people could live off of that just fine, possibly making some adjustments to your lifestyle.
However, if you still have a mortgage payment and/or have health concerns, you will probably require a much larger nest egg to be on the safe side and to have a more comfortable retirement. To be prudent and not burden your children or relatives with having to care for you when the time comes, you will probably want to include a worst case scenario as well where you'd require assisted living for the last 5-10 years of your life, etc. That is currently around 40,000 per year per person! So as you can see, that $50,000 a year might be enough in good times, but in bad times you'll be underfunded.
I'd describe our personal situation as needing to play a bit of catchup to get where we want to be for retirement, based on the results above. We're both currently 38 years old and we have 401k accounts that we have been contributing to, but I'd guess probably only around 6% over time. There were also a few years that we had jobs that didn't have 401k accounts or we just hadn't gotten around to bumping our contribution level above whatever the minimum was. In addition, I was at a company called Global Crossing back in the late 90s that went Chapter 11 and my approx $36,000 401k account in 1999 went to not much more than 0. That was a tough lesson, make SURE that you don't have more than 10% of your 401k going into company stock. It was common at the time for all of your company matching $ to go to company stock, but I think that has changed due to situations like that and Enron. I ended up getting I think $9,000 back from a class action lawsuit, which is better than nothing, but still a rough lesson to learn. At least I have the time to make up for that, many others were close to retirement and in far worse situations.
Becoming recently debt free has allowed us to focus on catching up. We recently funded a Roth IRA for both of us for last year and we will have our Roth IRAs fully funded each year going forward with regular contributions every other week. In addition, we bumped our 401k contribution percentages to 15%. The 15% level is what Dave recommends once you have your emergency fund fully funded and are debt free minus the house. Since we're actually funding our Roth IRAs and then contributing an additional 15% towards our 401ks we're actually well over the 15%, but like I said, we need to play catchup.
For us, I'm generically picking a retirement age of 63, which would give us a 25 year time frame. Based on what we currently have in 401k accounts as a starting number, if we were to contribute $2,250 per month for 25 years assuming a 6% rate of return we'd end up right around that $2 million mark that I mentioned above. That tells me we're still not funding our retirement accounts enough based strictly on that information alone.
However, lots of factors can change the formula over time. For example, my wife is currently pursuing her Bachelors degree and hopes to increase her salary a good amount over 5+ years. If she doubled her salary in say 5 years, the amount of $ going into her 401k would double, increasing our total amount at retirement. Also, I kept all other numbers the same for my example, just changing the rate of return from 6% to 10% over the 25 year time frame and my total at retirement went from $2 million to $4.2 million! So that is encouraging as well. I have 1/2 of my existing 401k money in a rollover 401k trading account and my personal goal for a rate of return is over 12%, but that is easier said than done on a consistent basis.
In reality we hope to have the financial freedom to retire much earlier than 63, if that is what we decide we want to do. If you've read some of my prior posts, you know that my ultimate goal is to be able to trade the stock market on a daily basis from anywhere in the world. If I continue on that path and decide it's everything I had hoped for, then I would probably continue doing that forever and never officially retire.
The bottom line is that situations change and you will have to adjust your retirement contributions along the way. However, the sooner you can get started and the more you can contribute early on, the more your $ will be working for you due to the power of compounding interest and time!
Investment OptionsIf you are looking for a "set it and forget it" investment account, Vanguard has some of the lowest fee mutual funds and ETFs in the industry. You can pick from one of their Target Date Funds that automatically change the allocation over time and setup an automatic investment schedule to pull funds from a bank account to average in over time and be done.
If you are looking for a place to open an online investing account, OptionsHouse is a great option, pun intended. You can get 100 free trades and stock trades are only $3.95. In addition they have excellent webinars and their trading app is available for all the major mobile devices and tablets.
Speaking of tablets, if the idea of 100 commission free trades doesn't get you excited, you could instead choose a FREE Kindle Fire HD from OptionsHouse. That is an exclusive offer available only through my link. It could expire at any time, so if you are interested I'd recommend taking action soon.
Whether you choose the 100 commission free trades or the free Kindle Fire HD, you would still get the amazingly low $3.95 rate for stock trades.
If you happen to be interested in trading options or learning how to trade options, OptionsHouse is also rated as one of the top online brokers for trading options by Barrons for 2013 and they offer very low commissions of $5 for 5 options contracts. That rate is over 50% cheaper than competing brokers.
Keeping your costs down is important in order to maximize your rate of return over time and OptionsHouse allows you to keep those cost to an absolute minimum while providing all the tools necessary to make sound investment decisions.