Starting a retirement plan early is the single easiest way to grow an impressive nest egg
If you tell the average twenty-two year old Millennial that the best time to start saving for retirement is yesterday, they may throw you an incredulous glance. “Are you kidding?” they may say, “I’m not due to retire for another forty years!”
Millennials, usually defined as those born between 1980 and the early 2000s, may go on to argue that they’re busy starting a family or paying down student loans and they simply don’t have the money to worry about retirement.
However, according to Financial Advisor, T. Gregory Naples, starting your retirement plan early and taking advantage of compound interest is the single easiest way to retire with an impressive nest egg.
The magic of compound interest
Naples, who runs The Naples Wealth Management Group in Hudson, Ohio with his son Christopher, often tries to catch the attention of the children and grandchildren of his clients by pitching them a series of quick scenarios.
One such scenario is the simple math of compound interest. Say 22-year-old Bob makes $60,000 a year and retires at 65. He contributes 10% of his pre-tax salary into his 401(k) retirement account while his employer chips in 2%. Assuming he consistently makes that 12% monthly contribution of $600 at a reasonable 5% rate of return, he’ll end up with $1,057,000 at retirement.
Sally, however, contributes $1,000 a month at the same rate of return, but she doesn’t start until age 45. By the age of 65 she will have $448,000 in her retirement account—roughly 43% of what Bob has saved. Witness the power of compound interest at work.
While many investors go in search of the magic triple-digit stock gain, Naples says young investors shouldn’t overlook the power of consistent contributions that take advantage of compound interest—even if the contributions begin very small.
Even small amounts make a big difference
A frequent complaint that Naples hears from Millennials is that they simply don’t have the excess cash to invest. Using the example of Bob and Sally, he fights this misconception as well.
Say Bob complains that he can only afford to put away 4% a month due to his student loan and tight budget. Assuming the same rate of return over 43 years and a 2% employer match, he will have $528,000 at retirement—still 8.4% more than Sally even though his monthly contribution was 40% less than hers and overall he contributed $103,000 compared to her $240,000.
While that may not be enough for Bob to retire on, a recent study by the US Government Accountability Office showed that 29% of Americans over 55 have no retirement savings whatsoever1. So even small contributions can make a big difference to your overall retirement savings.
Naples uses examples such as these to catch Millennials’ attention. Once they’re convinced, he starts them out in managed mutual funds until they reach $50,000. After that, he often switches them to more transparent and lower-cost stock and bond funds managed by institutional money managers.
Financial education that pays in the long run
Naples also seeks to educate Millennials about Modern Portfolio Theory and the importance of consistent contributions in a tax-free environment, as well as diversification and rebalancing concepts to smooth long-term returns through bear and bull markets.
But first and foremost, Naples tells them to use the tax-free environment of the 401(k) to put compound interest to work for them. “I tell them it’s the most important investment they’ll make for their retirement. It’s literally like watching grass grow.”
1 United States Government Accountability Office, Most Households Approaching Retirement Have Low Savings.
The case studies presented are provided for illustrative purposes only. Past performance is no guarantee of future results. The information has been obtained from sources we believe to be reliable, but we cannot guarantee its accuracy or completeness. Each customer’s specific situation, goals, and results, may differ.
Bonds, if held to maturity, provide a fixed rate of return and a fixed principal value. Bond funds fluctuate and shares, when redeemed, may be worth more or less than their original cost. Bond funds and bond holdings have the same interest rate, inflation and credit risks that are associated with the underlying bonds owned by the funds. The return of principal in bond funds and in funds with significant bond holdings, is not guaranteed.
Tax laws are complex and subject to change. Morgan Stanley Smith Barney LLC (“Morgan Stanley”), its affiliates and Morgan Stanley Financial Advisors and Private Wealth Advisors do not provide tax or legal advice and are not “fiduciaries” (under ERISA, the Internal Revenue Code or otherwise) with respect to the services or activities described herein except as otherwise provided in a written agreement with Morgan Stanley. Individuals are encouraged to consult their tax and legal advisors (a) before establishing a retirement plan or account, and (b) regarding any potential tax, ERISA and related consequences of any investments made under such plan or account.