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Retire young with a focused financial investment plan. Larry Ferstenou, in You CAN Retire Young, tells how to retire in your 40s or 50s. The following article will get you thinking about some basic investment moves for your financial investment plan. For all the right moves, see Ferstenou's indispensable book.
Three Investment Moves to Help You Retire YoungBy Larry FerstenouAuthor of You CAN Retire Young
Are you among the millions of American workers who would like to retire by age 55? If so, do you have what it takes—motivation and effective strategies? While the determination will have to come from within, here are three investment moves that can spell the difference between retiring early, retiring late, or not retiring at all.
(1) Maximize Your Tax-Deductible, Tax-Deferred Contributions This covers your 401(k), 403(b), 457, SEP, IRA or any other tax-deferred plan that is available to you. Contributions to these plans are tax-deductible—except for IRAs if you earn too much income—so that your tax liability is decreased in the year you make the investment. They grow tax-deferred, meaning all of the dividends and capital gains continue to accumulate from year-to-year and grow faster because they are not being reduced annually by taxes. And because large surprise capital gains distributions from stock mutual funds at year-end do not cost you anything in taxes in these accounts, you can also afford to invest more aggressively if you choose. The primary advantage of a 401(k) or other employer-sponsored retirement plan is that there is often some kind of employer match. That is free money to you, but you must invest your own money to get their match. Don’t think you can afford to invest more to get those matching contributions? Virtually everyone spends money in areas where they could cut back if they wanted to save more; for example, smoking, drinking, dining out, entertainment, ATM fees, cable TV, and convenience items like cell phones. In the “2002 Retirement Confidence Survey” co-sponsored by the Employee Benefits Research Institute (www.ebri.org) and the American Savings Education Council (www.asec.org), 70 percent of workers already saving for retirement indicated that it would be possible for them to save an extra $20 per week by cutting back on entertainment or dining out. Sixty-two percent of the surveyed workers who were not currently saving for retirement also reported that they could save $20 per week for retirement While that may not sound like a lot, it can accumulate faster than you think. Investing $20 per week for 25 years in a tax-deferred mutual fund returning an average 10 percent per year will total a little over $102,000; over 30 years it will total $171,100. You won’t be able to retire solely on that, but it will certainly contribute to a better retirement than if you hadn’t saved anything. If saving money is not one of your strengths, another advantage of employer-sponsored retirement plans is that the money is taken from your paycheck before you ever see it. And what you do not have in your hands, you are less likely to miss. All employees who have the opportunity to participate in employer-sponsored retirement plans should contribute as much as they can afford in order to get as much of their employer’s match as possible. Your employer is giving you free money, not unlike giving you a raise. If you want to retire, and especially retire young, you must maximize your tax-deferred retirement accounts.
(2) Start Investing As Early As Possible The power of tax-deferred compounding of your money cannot be over-emphasized. The earlier you start investing, the more your money works for you. For example, assume that two 22-year olds have recently graduated from college and are starting their careers. Graduate A starts an IRA and invests $2,000 each year for 10 consecutive years ($20,000 total). No other dollars are added but that $20,000 is left to ride in the account at a 10 percent average annual return until retirement at age 67. Graduate B procrastinates and doesn’t start investing in an IRA until age 32, but then puts away $2,000 every year for the next 35 consecutive years (a total of $70,000) at the same 10 percent average annual return. Who will have the most money when they both retire at age 67? Would you believe Graduate A? And it isn’t even close!
Consider another example. If you can manage to save $100,000 in a tax-deferred account earning an average annual return of 10 percent, your money will grow to $500,000 in 17 years. However, it will take less than half as long—a little over 7 years—to see it double to a million dollars. And that’s without adding another penny to the account. It simply cannot be any clearer. While it is never too late to start investing for retirement, the sooner you start the faster your money grows as tax-deferred compounding works in your favor.
(3) Save As Much Of Your Annual Household Income As You Can If you recognize all the advantages of financial independence for your retirement, then the answer for achieving that goal is not difficult. What you must do is spend less and save more, especially as your household income increases. You must set aside a much higher proportion of your annual income than what most people do. According to the U.S. Department of Commerce (www.doc.gov), the average savings rate in America was only 1.6 percent in 2001 and 1.0 percent in 2000. If you are determined to achieve financial independence, then saving as much of your annual household income as possible will be necessary. Assume your two-person household (both age 25) earns $50,000 per year after taxes and you save the 2001 average of 1.6 percent for retirement—that’s all of $800 per year. What are the chances you will retire early? None. After 20 years you will have contributed $16,000, which will have compounded to $45,800 tax-deferred given a 10 percent average annual return; after 25 years, it will have compounded to a mere $78,700. Worse yet, a 3.5 percent inflation rate will cut those totals significantly. You won’t retire early on that unless you plan to inherit a lot of money or have a substantial employer-funded retirement to supplement it!
At an $800 per year set-aside for retirement, it will take you 44 years to accumulate $522,100 on a tax-deferred basis. If you start saving at age 25, you will still not have enough money to retire at 69 because inflation will have eroded the purchasing power of your money to $173,100 in today’s dollars (based on a 3.5 percent inflation rate). If you did not start saving until you were 30, which would make you 74 at retirement after 44 years, you better hope Social Security is still around doling out enough for you to survive. But what if in this same scenario you save 30 percent of your $50,000 after-tax annual income—the minimum the author and his wife saved on average? It’s an entirely different story. You can plan your exit from full-time employment while your friends (who didn’t save) continue to grind away from day to day.
After 20 years the $300,000 you contributed to your retirement accounts has grown tax-deferred at an average 10 percent return to $859,100. Even inflation-adjusted that would be enough for many people to retire. If you are 25 years old reading this, you can potentially retire at 45 with well over three-quarters of a million dollars (over a half-million inflation-adjusted). In fact, you can probably retire younger than that, depending on the lifestyle you want to live. But if you wait another five years and retire at the grand old age of 50, your account will be worth $1.5 million ($856,200 inflation-adjusted). And if you decide to wait until 67 to retire? You will have $8.1 million ($2.8 million inflation-adjusted) securing a most comfortable retirement.
You CAN Retire Young! As clearly illustrated in those examples, if you have an above-average income, start investing early, and set aside a significant percentage of your income, it is not impossible that you could retire as young as your late 30s, but surely in your 40s or 50s. You will be in a position to: (1) continue working full-time and prepare for a more luxurious retirement lifestyle later, (2) semi-retire (work part-time), or (3) fully retire and never work again. But the only way you can give yourself those choices in the future is if you have a sufficient net worth. Anyone earning less than the $50,000 per year used in these examples should not be discouraged. If you are a prodigious saver who starts early and contributes as much as possible to your tax-deferred retirement accounts, you will either accelerate your retirement date or at least accumulate significantly more money for a secure retirement than would otherwise be possible. Saving a higher percentage of your household income is feasible once you convince yourself that the end justifies the means. Establish your spending priorities with a goal of saving money to retire young and you will be well on your way to achieving that goal.
Larry Ferstenou retired over ten years ago at age 42 and is the author of You CAN Retire Young! How To Retire in Your 40s or 50s Without Being Rich (American Book Business Press, 2002). More information can be found at www.youcanretireyoung.com. Copyright © Larry A. Ferstenou, 2002–2003.
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