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The Best Reason to Start Saving for Retirement Today

The Best Reason to Start Saving for Retirement Today

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The Best Reason to Start Saving for Retirement Today

It's common knowledge that getting started saving for retirement early will make the journey much easier. You can get by with saving much less per month if you have decades before you retire.

But maybe you have financial priorities you want to take care of before you start saving, figuring you'll be able to dedicate much more of your income to retirement savings later in life. Even if you have a reasonable plan to reach your savings goal in a short period leading up to your planned retirement date, you're taking on a big risk you would avoid by starting early.

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Leaving room for error

Stock prices don't increase at a steady pace every year. Yet most long-term financial planning is done with the idea of an expected return, which determines how much you need to save each month or year to meet your goals.

For example, if you expect the stock market to produce a real return of 7% per year for the next 40 years, you need to invest $382 per month (in today's dollars) to reach a goal of a portfolio valued at $1 million (in today's dollars).

But it's very likely you'll have a much different amount than $1 million when you actually get to 2062 if you don't adjust your plan in the intervening years. That's because you may hit a sequence of returns where the stock market performs really well early on in your savings journey, but then performs poorly later. That will lead you to fall short of your goal, even if the average return over those 40 years turned out to be spot on in your predictions. Likewise, the opposite can happen, leading you to accumulate much more wealth than you'd planned.

You never know when a period of strong returns is going to occur. The longer your investment horizon, the more likely you are to catch a period of exceptional returns. If you wait to invest, you might miss out.

The average real return of the S&P 500 over any 40-year historical period is 6.5%. The average return over any 10-year period is actually a bit higher, at 6.9%. But the market is much less predictable in 10-year increments than 40-year increments. The standard deviation of returns for 10-year periods is 5.1% compared to just 1.4% for 40-year periods.

Put another way, there's a 90% chance the market returns more than 4.9% in any 40-year period. Over a 10-year period, there's only about a 65% chance of producing a 4.9% average return. And while there's a chance market returns don't even keep up with inflation in a 10-year period, that's never happened over a 40-year period.

Prioritize retirement savings

Even if you're just starting your career, you should try to contribute something to your retirement savings every month. An employer match on your 401(k) is a great incentive to get you started saving as early as possible.

Even if you're very debt averse, you'll do well to pay down your mortgage (or any low-interest debt) slowly if you're still young. That's especially true if you've locked in an extremely low rate. While paying down the mortgage provides a guaranteed return on your investment, you'll likely be able to earn a greater return by investing in the stock market. That's especially true with a longer time horizon. That said, the payoff for investing over paying down the mortgage becomes less certain with a shorter horizon.

By prioritizing your retirement savings early, you're more likely to hit your long term goals, mitigating the potential for sequence-of-return risk.

The $18,984 Social Security bonus most retirees completely overlook

If you're like most Americans, you're a few years (or more) behind on your retirement savings. But a handful of little-known "Social Security secrets" could help ensure a boost in your retirement income. For example: one easy trick could pay you as much as $18,984 more... each year! Once you learn how to maximize your Social Security benefits, we think you could retire confidently with the peace of mind we're all after. Simply click here to discover how to learn more about these strategies.

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