I have read many articles and studies in my life about the advantage you gain from starting to save towards retirement earlier in life. There are always various assumptions made which make a huge difference to the statistics that end up being quoted. Since I have never crunched the numbers myself I thought it could be a nice exercise to look at a scenario analysis with several rates of return and number of savings years and see how sensitive this equation is to the two key variables.
I start my analysis with the assumption that we all want to retire as millionaires. There is no real reason I am picking $1 million other than that it still seems like a lot of money. We have to pick some number if we are going to solve for an amount you need to save each month and/or a return you need to make to get you there. It seems reasonable that once interest rates have risen back to normal levels to where you can get a decent 4-5 percent safe net return, a retirement pot of a cool million will yield a decent enough income to live comfortably.
Assuming a retirement age of 60, again a number I plucked straight out of thin air, I first solved for annual contribution required given a fixed return and differing numbers of years. Second, I assumed $1,000 per month with various rates of return and solved for what age you would need to start saving at to get your million bucks at age 60. The results are pretty interesting and are summed in the tables below.
The most interesting thing to notice is that the greater sensitivity within the realm of reasonable returns to achieve on your investments is to the savings time frame. If you start saving at age 45, saving $3,000 per month will just about get you to $1 million given a compounded average return of 8 percent. However, add one decade of saving and you can get to the same place with just over a $1,100 per month. Notice that if you start saving a thousand bucks a month even with a compound annual return of 12 percent you would still need over twenty years to get to your goal. If you start saving at age 25, you could save as little as $500 per month if you could average 8 percent over the entire time horizon. While given such a long time frame that should not be too difficult, even a more conservative return such as 4 percent needs just over a thousand dollars a month to give you a million dollar pot at age 60.
The main thing to get from this exercise is that you can get away with taking very little risk and still end up with a nice retirement pot if you start early enough. Even if you have started a bit late, do not go into riskier investments than you are comfortable with to try and make up for lost time. Even if you achieve a slightly higher return, the shorter time frame will not allow it to have that much affect. Yet you are more likely to suffer a loss you can’t really afford if you go after above average returns. The ironic thing about the longer time frames is that it is much easier to safely achieve a higher rate of return, yet it isn’t as important in achieving your saving goal.
David Mayes MBA provides wealth management services to expatriates throughout South East Asia, focusing on UK Pension Transfers. He can be reached at david.m@faramond.com. Faramond UK is regulated by the FCA and provides advice on pensions and taxation.
