Financial security ranks in my top three for long-term happiness (the other two are personal relationships and health). Simply put, it’s hard to enjoy life if you are constantly worrying about how to make ends meet.
To that end, this post is about an easy way that you can give your future self a small financial security blanket (see what I did there… SECURITY blanket… like stocks and bonds… I know I’m terrible).
There are a million posts on a million blogs about why you should be saving for retirement. And just FYI, they’re all right. You SHOULD be saving for retirement unless you’re already retired (or have a ton of bad debt).
In this post I’ll point out the hypothetical future gains of maxing out a Roth IRA just once before you turn 30. Since the max annual contribution in 2013 is $5500 if you’re under 50, that’s the number I’ll be using today.
I decided to go with a Roth in this example because it makes the gains simpler to wrap your head around. You don’t have to figure out how much it will be post-tax because it’s already post-tax.
For those who don’t know much about IRA’s, here’s the nitty-gritty:
- IRA stands for Individual Retirement Account.
- An IRA is not an investment by itself. It’s a special account where you can put whatever investments you want (with some restrictions) and those investments get special tax treatment.
- There are two types: Traditional and Roth.
- In a Traditional you invest pre-tax money (similar to a 401(k) or 403(b)), and when you take the money out it gets taxed.
- In a Roth you invest post-tax money and when you take the money out it’s all yours, no taxes.
- You have to wait until you are 59 and 1/2 to take your earnings out of an IRA or you pay a penalty.
If you want to know more than that you should just google it and read up a bit.
Essentially, Uncle Sam doesn’t want you to be a huge burden on state and federal systems so he’s encouraging you to invest in your future by giving you some tax breaks.
So let’s assume that when you are 29 years old, you maxed out your Roth IRA with $5500 just before your 30th birthday. To keep things simple, let’s just assume you invested it in an index fund such as Vanguard’s Total Stock Market Index.
For a little historical data, the worst 35-year return in stock market history averages to about 6.1% per year (spans the Great Depression). The best 35-year return averages to about 12.9% per year. The average 35-year return averages to about 9.7% per year. [source]
Using these number as benchmarks let’s see how much money you have when you turn 60, after 30 years.
- With a 6% return: $31,589
- With a 7% return: $41,867
- With an 8% return: $55,345
- With a 9.7% return: $88,422
- With a 12.9% return: $209,499
Some things should be seriously jumping out to you right about now. First is that a difference of even 1% has a huge impact over a 30 year time horizon. Choose your investments wisely. I have my IRA with Vanguard. They are an investor-owned company with the lowest fees in the industry. And, as we can see, even a 1% fee means a lot of money over 30 years.
Next is that even if you got the worst return in the history of the stock market, you would still end up with more than $30,000. And the average scenario? Banking $88,000+. Think about that for a minute. Seriously, let it sink in.
You scrimped together $5500 before you turned 30 and now in your golden years, it’s turned into almost 90 grand.
Of course, as all investing websites say, past results don’t guarantee future returns, and you should definitely research every investment you make.
But for my money, I think I can save a few thousand dollars now for the potential of turning it into 200 grand!!! That’s big boy money right there (or big girl money for the ladies).
And that’s assuming you don’t ever save or invest another dollar! What if you had $10,000? $20,000? The point is that compounding interest works best with a long time horizon, so investing early is crucial if you want big returns.
So go open a Roth IRA today if you don’t have one. Scrape together some cash and give your future self some beer money.
In other news, the picture at the top of this post really cracks me up so you can definitely expect to see it again in a future post.