When you picture your retirement, do you see yourself working in a fast food restaurant or as a greeter for a chain superstore? Probably not. If your vision of the ideal retirement lifestyle is more along the lines of travel, hobbies, movies and good books, and time with friends and family, then you've got to start preparing for it today.
1. Compound Interest Makes Your Money Grow Faster
Everyone knows you should avoid putting two rabbits together unless you want to end up with a whole barn full of bunnies. In no time, a couple of hares can turn into hundreds. Besides providing an elementary lesson in family planning, the rabbit example offers a lesson in compound interest, which Einstein called the eighth wonder of the world. In a nutshell, compound interest means earning money on your investment earnings.
To illustrate the concept, take Jenny, who's 22 years old when she starts contributing $2,000 a year to her retirement plan. She stops after nine years with a total of $18,000 invested and lets her money grow at a 9 percent rate of return. At this rate, when she is 65, her nest egg will have grown to $579,468.
Jenny's friend Dave, on the other hand, waits until he's 31 before he starts contributing $2,000 a year to his retirement plan. Instead of stopping after nine years, he continues to invest until he is age 65 -- a full 35 years and a total of $70,000. How much will he end up with? Dave will retire with $470,249 -- $109,219 less than Jenny after investing nearly four times as much!
Follow Jenny's example and start saving early so that compound interest has time to work its magic on your money.
2. Increase Your Savings by Avoiding Taxes
Why put off until tomorrow what you can do today? Because, when it comes to paying taxes, avoidance pays off. The longer you can keep the IRS waiting for its share of your bankroll, the more you get to invest for yourself. If you thought compound interest had a powerful effect on its own, imagine combining it with tax deferral.
The great thing is that the IRS actually approves of -- even encourages -- savers to avoid taxes. IRAs and employer-sponsored retirement plans offer tax-deferred or tax-free growth on contributions that may be tax-deductible or made with pre-tax dollars. The table below shows how much faster your money can grow unencumbered by taxes.
3. Employer Matching Contributions Are Like a Bonus Every Payday
It must be great to get a bonus every single payday, even when you're on vacation or your boss is in a bad mood. What? You're not aware of the "payday bonus plan" your company offers? Well, that's exactly what you're getting if you work for a business that matches employees' contributions to their retirement plan.
Another way to look at the "company match" is as a guaranteed return on your money. Would you buy a stock if your broker guaranteed you would make money on it? You bet. Well, when your company matches, say, 50 cents on every dollar you save, you're getting a 50 percent return on your investment. That's an incredible return! And you thought you weren't a savvy investor.
To get the matching funds offered by your employer, you need to do just one thing: Participate in the company's retirement plan. Every pay period you delay, you let another bonus slip through your hands.
4. Dollar-Cost Averaging Means Getting a Bargain on Stocks
If you could pinpoint exactly when a stock had hit its high and low points, you wouldn't have any need for dollar-cost averaging. If you haven't mastered that whole crystal ball thing yet, then dollar-cost averaging, or investing a set amount of money at regular intervals in a particular account or investment, can really improve your investment returns over time.
By investing the same amount each month or each pay period regardless of whether the market is up or down, you end up buying more shares when the price is lower and fewer shares when the price is higher. The net effect is a per-share purchase price for all your shares that can be lower than the actual average share price for the period.
In the hypothetical example below, dollar-cost averaging results in a 33% return for our investor. Not bad for someone who simply set up an investment plan and stuck to it. Be aware that dollar cost-averaging does not guarantee a profit, but is one of many strategies to reduce the risk of investing in securities that fluctuate in value.
Average share cost: $300 / 40 = $7.50
Current market price: $10
Total return: 33%
Time plays too big of a role in your financial success to waste any of it procrastinating.
There is no better time than today to get started planning for your dream retirement.
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