Hope was a pragmatic young lady who knew the importance of planning ahead. On her 18th birthday, she decided to start saving for retirement. Being a college student, she didn’t have much money to save, but she wanted to start with something.
A local bank had a plan that was perfect for Hope. She would get a fairly moderate 5.1% interest rate on her savings, provided she follow one rule: she must save some money every day, even if it was as little as one cent.
Hope started off saving five cents per day. She followed this plan until her 21st birthday, when she increased her savings to ten cents per day.
By her 25th birthday, she was enjoying a few years of full-time work, and raised her daily savings to 25 cents per day.
Turning 29, with her career taking shape, she increased her daily savings to 50 cents per day, and continued to save that amount each day until her 67th birthday.
On her 67th birthday, Hope went to the bank to see how she had done. Over the years, she had saved just over $7,500 — yet never took more than 50 cents out of her pocket. In her retirement account was much more than that: over $25,000 — more than three times what she had saved.
Sure, no one can retire on $25,000, but everyone can save as little as 50 cents per day. What if Hope was more aggressive in her savings? What if she had saved $1 every day for her entire adult life in the same retirement account (with its 5.1% interest)?
Saving $1 a day, with 5.1% interest, would have resulted in Hope putting nearly $18,000 in the bank over 48 years. With interest, her bank account would be worth over $75,000 — over four times her savings.
Of course, many people will be skeptical that someone can make 5% interest over 48 years, especially considering the current stock market conditions. However, history tells us that 5% is easy. According to the Political Calculations blog, if you took the worst 48 years in the history of the S&P 500 (from 1900 to 2004), you would make 5.1% on average. That’s 5.1% return on investment if you only invested in the worst years of the stock market. We all know that is nearly impossible (unless you truly are the unluckiest person alive, and if you are, stock market fluctuations are probably not your greatest concern).
A more realistic rate of return over the long haul for our dear friend Hope would be about 7.5%. In our original scenairo, if you increased the interest rate from 5.1% to 7.5%, Hope’s $7,500 savings would have yielded just under $49,000 on her 67th birthday (6 1/2 times savings). In the $1 a day scenairo, 7.5% interest would yield about $170,000 (more than nine times savings).
The best bet is to be very aggressive saving early on. If you saved $5 per day starting age 18, through age 29, then never saved another penny, and earned 7.5% interest, you’d have nearly $200,000 at age 67, after saving just $21,900.
The bottom line: save early, save often, and be in it for the long haul. Let the power of compound interest and dollar-cost averaging work for you. You don’t need to save like a rich man to become one — you just have to start as early as possible and be vigilant.
Words to live by, and — more importantly — words to teach your children to live by.