Friday, August 18, 2006

Investing - Saving for Retirement part 4 - The time factor

Time. Try to define it. Nice try, but you can't. The definition you just thought of was probably a way to measure time, but not a definition of time itself.

Time does, however, have a significant impact on your retirement strategy. Specifically, the number years you contribute to your retirement savings will make a huge difference when it's time to cash out. I read an article once (I'll try to find a link and post it) that showed an example of three different people who invested the same amount of money over different five year periods, then stopped contributing to their retirement account. For the purpose of this example, it is irrelevant whether these people have an IRA vs. a 401K. As long as the money is going into a tax deferred account, this works. The article also assumes a constant rate of return and that each of these people started to cash out at age 65.

Person 1 started to contribute at age 25 and made contributions until age 30.
Person 2 started to contribute at age 35 and made contributions until age 40.
Person 3 started to contribute at age 45 and made contributions until age 50.

After their 5 years on contributing, they never made another contribution again. The overall point of the article is to show the significant difference that person 1 has over person 2 and 3, and that the earlier you start investing, the better off you will be.

Let's plug in some numbers to illustrate the differences. Let's say each person contributes $4000 a year and the average rate of return is 7% per year. At age 65, these are the projected results:

Person 1: $281,179.35
Person 2: $142,937.32
Person 3: $72,662.09

Remember - each person contributed a total of $20,000 ($4000 a year over 5 years), and each portfolio had the same rate of return. The only difference was time, and as you can see, it was
significant. Don't waste it.

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