My middle daughter will be graduating college in the next couple of weeks, and she has continued to hear me talk about the importance of how starting early in contributing to her 401(k) plan when she gets her first job.
I know we’ve talked about the importance of compound interest in the past, but today I want to walk through a specific scenario that you can convey to your kids and/or grandkids.
When my daughter starts her first job, she will be 23. And if she planned to work until 65, that would be a total of 42 years. Assuming that she had a salary of $50,000, and she contributes 10% of her pay to her 401(k) as I have suggested, that would be $5,000 per year. And if the employer were to match 3% of her salary, that would be an additional $1,500. So, her total contribution for the year would be $6,500.
If we used an assumed rate of return of 7%. Historically, the stock market over the last 50 years has averaged around 10%. Bonds have averaged between 5% and 6%, but for argument’s sake, let’s assume a 7% rate of return.
At age 65, assuming she continued to contribute just the $6,500 and never increased her contribution beyond the $6,500 during that 42 years, her total value in a retirement account would be worth $1,500,000.
Now, if we look at what her totals contributions were, she contributed $6,500 for 42 years so between her contributions and the employer match the total contributions would have been $273,000 during that 42 years, and with a value of a $1,500,000, she had a gain of $1,227,000.
Now, why is that important?
Let’s look at a different scenario. Let’s say that as soon as she graduates, she starts her new job, assuming she makes her same $50,000, but decides she needs a nice apartment and a new car and decides that she can’t afford to contribute to her 401(k) plan and says, I’ll contribute to that retirement plan later.
If she simply waits until age 33 and still plans to retire at 65, instead of investing for 42 years, she invests for 32 years. She still contributes the same $6,500 a year and still returns 7%, but at age 65, instead of having $1,500,000, she has $716,000, which is a difference of $784,000, simply by starting 10 years earlier.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly.
Stock investing involves risk including the loss of principal.
These are hypothetical examples and not representative of any specific situation. Your results will vary. The hypothetical rates of return used do not reflect the deduction of fees and charges inherent to investing.