Getting a handle on retirement: twenty-something version

In my last post, I gave a brief overview of the website I created that mimics the S&P 500 over the last 100 years, as it relates to simulating retirement saving potential. That post was geared toward older adults who are getting close to retirement age. Today's post is geared for the twenty-something who has just entered the workforce, and might not be thinking about retirement. The goal here is to remind those younger adults just how important the phrase it's never to early to prepare is.

If you don't want to read this post, I've created a short video that demonstrates how the planning too works. Just click this link to watch the video.

Why should I start planning for retirement in my early twenties?

As a general introduction to this question, let's revisit the graph I showed in my previous post:

The general trend of the S&P 500 over the last 100 years shows that it grows around 9% on average.

As you can see, the S&P 500 has a definite growth trend over its history. Sure, there are times it takes a dive (in red), and there are also times where it has phenomenal growth (in green). But overall, it grows. In fact, there is something called the Rule of 72: take an average rate of return, and divide it into 72. The result of that division tells you the estimated time for your investment to double. So, if you have an average rate of return of 9%, 72 / 9 = 8. That means, your investment doubles every 8 years. So, if you hold an investment for 40 years, you'll experience 5 doubling periods for that initial investment. If you decide to wait 8 years until you start investing, you'll lose an entire doubling period. That's not so important for the first doubling period, but is huge for the fourth or fifth doubling period.

Exploring what 40 years of investment will do

First the bad news. If you are 22 years old, you're going to be working for the next 40 years. Therefore, try and find something you enjoy. Now the good news: there's a lot of life to live in 40 years - marriage, children, grandchildren, great vacations, etc. So, embrace the ride, it's not so bad. But, 40 years is not only a long time to work, it's also a long time for investment income to grow. So, putting money into an investment early is really beneficial. And remember, time flies. Just think about how quickly your 4 years of college went. In the blink of an eye, you'll be 10 years older.

How your retirement plan might work

Chances are, you will work for a company that has a 401K, and hopefully, they will match some of what you put in on your own. Most 401Ks have a management team that chooses the investment strategy. Generally, those investments will attempt to mimic the S&P 500. They also are targeted toward your age. When I was in my twenties, the funds I selected were called a 2030 Fund, meaning, I was going to be at retirement age at around 2030. So, the funds were more aggressive early on, and then got more conservative as I approached retirement age.

Typical example for a 23 year old

Now, back to retirement planning. If you visit my site, you can start estimating how your retirement savings may play out. Let's assume you are 23 years old, and already have $8,000 in your retirement savings (maybe it is money you put away yourself, or maybe it was a fund your grandparents started, or something else). Then, let's assume your company has a 401K and between your contribution and theirs, you'll put in $6,000 a year. Obviously, as you get a raise, you can put a little bit more into your retirement savings, let's say 2.5%. With that information, let's do some estimating by filling in the boxes on my website like the following:

The intial starting year is not important. But, we'll seed the initial investment with $8,000, put in $6,000 every year, and actually increase that contribution by 2.5% each year. And finally, we'll look at the performance over the next 40 years.

Once you've filled in the information, you'll want to press the "Calculate retirement planning" button. What this button will do is simulate the S&P 500 returns over the last 100 years to calculate what your investments might look like after 40 years, for any given year you might have started investing. You'll see those results in the chart below:

Simulated returns for the S&P 500 given your initial investment and regular contributions.

I made a few highlights on the chart. For example, following the trend of the S&P 500 from 1926 to 1966 (40 years), you would have $6.5 million in your retirement account after 40 years. Had you started in 1939, you'd have $3.8 million, and in 1949, you'd have $5.1 million. You'll also see that while you began by investing $6,000 a year, by the time you are in your 60s, you'll have been investing $16,110. That's not too far fetched, as your salary will be much higher in 40 years.

I also circled an overall analysis that shows the interdecile range (the middle 80% of returns) over the 61 different scenarios. You'll notice that 80% of the time, the S&P would have returned between $4 million and $6 million. So, it's a pretty safe bet that you'll be in good shape when you are ready to retire.

Playing with different scenarios

In this program, you can change up some of the dials so to speak. Let's say you wanted to live large in your twenties, and decided to wait to begin saving for retirement until you are 30 years old. We can change the Look Ahead Years box from 40 years to 32 years, and the results would look like this:

Now, instead of having between $4 million and $6 million dollars, you'll have $1.4 and $3.4 million. Still pretty good, but look how much you left on the table by waiting! And why did this happen: it is because you lost a doubling period by waiting 8 years to invest. Just remember, if you want to look at a 40 year time horizon, the program will only be able to do that if there are documented returns from the S&P 500 - so, given that we are in 2026, the latest the program can look at a 40 year trends would be 1985. If you wanted to see what would happen if you started saving in 2001 (when 9/11 hit), you could only put in a 24 year time horizon (2001 + 24 = 2025).

Here's the dirty little secret: if you don't put in money toward retirement when you are younger and decide to catch up in later years by putting a lot of money into your retirement when you are old, you'll never catch up. You won't beat the person who put a little bit of money in when they were younger, and then let the market just grow.

Go ahead and play with other scenarios: wait until you are 40 years old (20 year time horizon), but put $15,000 in every year and see what you get - it will be way smaller. Or, what if you maximized your investments in the next two years and put in $20,000 (along with the initial $8,000), and then did nothing:

You'd have between $900K and $2 million, and you wouldn't have put a dime into your retirement for 38 years!!!! (please, don't do that!!). But again, you see how important those early years are as the interest gets to build.

Take away

If you are a young person just getting started, do the following:

• play around with this website to see what combinations of investments you are comfortable with, and get an idea of how prepared you might be for retirement.

• get signed up for your company's 401K, especially if they are willing to match your contribution.

• talk to a financial advisor about a long term plan.

• then, sit back and let the investments percolate over time.

That last point is fairly important. You don't want to be irresponsible by not keeping an eye on your investments, but at the same time, you don't want to drive yourself crazy, either. Long term investing that tries to mimic the S&P 500 is designed to percolate over many years - some years you'll lose a lot of money, other years you'll make a lot of money, and most years have moderate growth.

Best of luck as you get started in your career!