When last we spoke we had decided we needed $600K to retire comfortably. And I told you it was achievable. I hope you believed me, but if not… let me explain. The first step to understanding this is how to save for retirement. The second step is how to maximize returns. And the third is, what will $5,000 get you?
First, how can you save for retirement?
There are pure retirement plans, like 401Ks and IRAs. There are not as good retirement plans, like CDs and Brokerage accounts. And there are bad retirement plans, like savings accounts and putting the money under your pillow. For now, I’m not going to discuss pension plans, because they aren’t personal retirement strategies. I am going to base this all around IRAs, Individual Retirement Accounts. You can open one of these at a number of brokerage accounts, but since none of them pay me… I’ll recommend that Google recommend you one. There are multiple types of IRAs but the main ones are Traditional and Roth. When you contribute to a Traditional IRA, you don’t pay taxes on that money the year you put it in. When you contribute to a Roth, you don’t pay taxes on that money when you pull it out. You can flip the above statements and see the negative sides of each. What is better for you is an entirely different situation… but since this is for the average American wage, I’m going to go with the traditional IRA. This means that if you make $50K and contribute $5K to your IRA. The government says that you only made $45K this year and you will only be taxed on $45K of income.
So how do I maximize returns?
Well you have to invest. And you have to be willing to lose a bit in the short term to make much more in the long term. And the less you are investing, the more aggressive and risky you have to be. That last statement might be the hardest to practice, but trust me that the numbers are easy to understand. If you add in 18K a year, you are going to have placed 635K after 35 years and you wont need to make a cent of interest to retire. But if you put in 5000K a year, you need to turn that 175K into 600K. So how to maximize returns without killing your investment? Well the easiest is Index funds, specifically diversified international stocks and diversified large cap stocks(I’ll be referring to the S&P500 for this). Diversifying minimizes risk across sector, and investing in large companies reduces the risk of volatility. I’ll explain these both later as well, and maybe I’ll have a sponsor and can push their fund on you.
So what will $5K get you and why do I keep mentioning $5K?
Well $5K is a nice round number. It is also 10% of a $50K salary, which is the average American wage. The annual return aggressive portfolios mark for is 8%. What does that mean in practical terms? If you put away 5K in an S&P500 fund for 35 years, you will have turned that $175K into $861K. But lets be more realistic… what did the S&P average for the past 35 years? You remember the crash in 2009… that must have destroyed retirements. Well the return between 1981 and 2016 was 12.39%, almost 4.5% better than aggressive portfolios benchmark against. If you invested $5K for the past 35 years you would actually have well over 1 million dollars in your retirement fund. But hold up, I can’t afford $5K. Okay, well the good news is that for just $3.5K, you will reach $600K in 35 years. What is 3.5 in relative terms? That’s $292 a month. It might seem like a lot, but I believe in you.
So what if I’m not 22 and I don’t have 35 years to go? Well the good news is you aren’t fucked. Start now. And contribute as much as you can. And don’t get blinded by the idea of moderate portfolios. If you are older or don’t have much money to contribute, go aggressive or go home.