I'm 32 and I want a Million

[Guest nicki]

I heard Suze today talk about a 22 year old that saves $100 a month in a Roth Ira would have a little over a million by the time they were 65 and that the same person who waits uintil they are 32 at that amount would only have $700,000. Does anybody know how I at 32 could have a million by 65 or where I can go to help me figure out what I need to do?

[david rigby]

Compound interest.

If you invest $100 per month for 40 years and get a 12% annual return (I assumed 1% per month for simplicity), you will have about $1,175,000 at the end of 40 years. If you did the same thing for 30 years, the amount would be about $350,000.

However, don't forget the inflation component. That is, part of the rate of return is reflective of inflation. If that is 4% for 40 years, then that gallon of gas that costs $1.50 today will be over $7.00, taking in account inflation only. If the inflation rate is 5% (instead of 4%), then the gallon costs about $10.50.

Not sure where Suze got her numbers or what interest rate she assumed. Such statements are generally of no value without such information.

[david rigby]

You might also want to look at this "calculator" provided by the American Academy of Actuaries.

http://www.actuary.org/briefings/pension20..._calculator.htm

[John A]

pax,

there are 2 things that always trouble me about accumulation projections of periodic additions to an account:

1) there is a large difference in the accumulations depending on when higher and lower rates are earned. While the accumulation of $10,000 over 10 years at 5% and then 10 addtional years is the same as $10,000 over 10 years at 9% and then 10 additional years at 5%, this is not true for periodic additions. $10,000 at the beginning of each year at 5% for 10 years and then an additional 10 years at 9% is approximately $478,000, while earning the 9% first and then the 5% is about $402,000. Yet both would be the same average "rate of interest" over the 20 years.

2) A substantial portion of the total accumulation projection is due to the last year or few years of the accumulation, and no adjustment is made for the possible need to be more conservative in the last few years.

I realize that any projection that is not tailored to an individual is necessarily oversimplified, but I do wish the above 2 areas would at least be discussed in popular financial planning books.

[John G]

Nicki, you can do the math using an HP 12c calculator or any general spreadsheet. The variables are N (number of compound periods), PMT (contribution in each period), and I (interest rate).

Lets use ROTH IRA as an example for you. I will assume that you contribute until you retire at 65 (33 years) and hold a broad portfolio of stocks, such as an index fund and using 10% for annual appreciation. If you invest $2,000 each year you have $444k at age 65. If you and your spouse both invest $2,000 each year, just double that to $888k. If you bump up your contribution to $3,000 and your spouse does the same, then you hit $1,334k at age 65. Yes, 1.3 million in year 2034 dollars. Allowed IRA contributions are moving up to 5,000 so you can run some additional scenarios. You also will end up with a better result if your annual appreciation climbs just a little over 10%.

To convert any of these numbers to todays purchase value, you divide by (1+inflation)**N. That's and expotential equation easily solved on most calculators. I would suggest 3% as the long run inflation rate.... so (1+0.03)** 33years = 2.65 Dividing 1.3 million by 2.65 says that in today's purchasing value you tax shelter is equivalent to about a 1/2 million in today's dollars.

John A offers two valid points. First, your actual return will vary from year to year and so this estimation technique is crude. I agree. Second, much of the gain in assets occurs in the final few years when you might shift to more conservative investments. This also may be true. The rule of 72 says that with 10% a year appreciation, your assets double approximately ever 7 years. Therefore, your target total is 1/2 with 7 years to go or when you are 58. Your target total is just 1/4 with 14 years to go when you are 51. Where I would disagree is that at age 51 or 58 you are likely to have many years of work followed by even more years of retirement. Therefore you should not shift dramatically away from stocks with a few years to go to retirement. Once you reach the age of 65, your odds of living another 30 years are significant.

There are other keys to buiding wealth: (1) choose you spouse carefully, long term married couples are more successful, (2) participate in corporate retirement plans that have a matching component, (3) utilize the long term value of homeownership to build equity, (4) consider starting your own business if you have the fortitude and can-do attitude, (5) build a tax sheltered asset base using Roth IRAs, and (6) stay with your plan, time is an investors friend.

I am not a big fan of Suze... she throws numbers around a lot for dramatic effect and leaves out the details. If she set off your internal alarm that motivates you to become educated about investments and get started, then that is a good thing. Don't think age 32 is too late to achieve great results.

Good luck.

[John A]

John G - good post - Nicki should find it helpful. But what you really point out is an additional area that bothers me - often there is no discussion of planning for the spending (retirement) years. That $1 million accumulation at retirement could easily become $900,000, $800,000 or less one year later, even with reasonable investments. However, putting the $1 mil into a guaranteed interest rate (like a 30-year bond, or purchasing an annuity) subjects the retiree to inflation risk, and could be just as bad in a high inflation time. I agree that a person of any age should have at least some assets in stocks, but I would still say that a person near the peak of their accumulation (last few years before or first few years after retirement) should consider each type of risk, and may want to be somewhat more conservative than someone who is just starting to accumulate.

Also, there are many stories currently of people who are planning on working to a later age than originally planned, because the recent market doldrums have left them with much different accumulation projections than the projections they had counted on 1 or 2 years ago. Any projection is almost guaranteed to be wrong, but they are useful if they are used as "course corrections" (I need to save more, I need to learn to invest, I need to protect against inflation, I can't withdraw as much as I thought I could each year, etc.).

[Greg Judd]

re: John G's comment: "Nicki, you can do the math using an HP 12c calculator or any general spreadsheet. "

Financial Engines' free tools enable you to do similar projections, with special twists & turns of their own, such as identifying particular investments & sums to start with & amounts to add to them. (I'm not a FE employee, nor a paying customer, I just like their calculation toys).

As John & others have remarked, the future will be what it will be; the projections just help you get your mind around the possibilities.

[John G]

The "at retirement" issue....

When a person gets to that magic age, they shift from payroll coming in to using a combination of pension, SSN and retirement assets. At the age of 65, most folks would clearly expect to live 20 more years if they are in good health. This could mean they are not going to touch even 10% of their IRA accounts in those initial years. Often, the IRA assets are not taken until forced MDR.

This means that the bulk of the assets will be working for 10+ years and it makes sense to keep a portion invested in equities.

Of course, not everyone can tolerate the annual flucuations. I am advising a 78 year old woman who was put into high tech funds by those loving folks at Morgan Stanley Dean Witter. They are going to lose the account because of that foolishness. She could not sleep because of the havoc with her retirement money. High tech, international telecom, etc. Very bad choices. Good choices could have been a general market index fund, growth and income or dividend based fund.

I do not disagree that as you get older you start to change to focus of your investments. But not the day after you retire. It should be a very careful and gradual change. If your assets vastly exceed your needs, you can take more risk. If you just have enough to meet your retirement goals, then you want to risk much less.

Nicki, don't worry about this debate. Your first goal is to get started. You will learn by doing. Don't worry about what your return is over the next few years. You are playing for the long haul. You probably paid a lot more in tuition for knowledge that may not be useful when you were in college.

Suggestion: subscribe to Kiplinger Financial mag and spend 1-2 hours each month reading the articles.

[John A]

John G - I'm not sure it's a debate since I have yet to disagree with anything in your posts. One quick note - even "general market index funds," which I agree would be good choices, have lost 15% to 20% over the last year. That does not make these funds bad investments - it just points out that even good investments can lose quite a bit over a short period. As you point out, many people will have 10, 20 or even 30+ years in retirement, so they have time to make up the loss. And if they do not need to touch the principal anyway, it may not be a problem. But no one I know can truly predict whether than 15% to 20% loss will be recovered in 1 year, 5 years, 10 years, or longer (although the longer the period the more likely that the loss will have been recovered).

Nicki - John G has offered some good advice. Start now.

[david rigby]

Some similar discussion here:

http://benefitslink.com/boards/index.php?showtopic=6713

[John A]

pax - nice link. One last point that reflects my personal bias - give 10% of your income away. It may not make sense, but there is something about it that actually does help with financial planning, and there is something about it that adds to one's "wealth."

[John G]

Pax, that really was a good link.... we covered some really good issues in that series.

John A, debate was a poor choice of words, we have a good flow of ideas. On donation to others, I agree. For those just getting started, perhaps the best donation is their time. Community service gets you out of the 9-5 thinking. You meet new folks and gain a different perspective on your life. Folks that cause trouble (like those two guys at Columbine) rarely have altruistic activities. Being self centered is about the most boring thing a person can do. For some couples this can be church related, for others... help in a recycling center, volunteer at a local school (Junior Achievement, reading assistant, coach), work in a local park & rec center, help out in the local hospital. Some of my best hours each week is spent trying to teach practical economics to junior/seniors in local high schools... it is a great challenge.

Donating $$$ is also helpful, especially when you accumulate some major bucks. Got more than milk? Like appreciated assets held for more than one year? Check the charitable gift programs at Fidelity and Schwab. Transfer 1000 shares of stock, take the full right off in the year of transfer and then you have a pool of money from which checks can be sent to various agencies. Like a mini Ford Foundation. I think it is either 10k or 20k to get started. Very cool. I look around at some families and see that the "heirs" can be the worse group to show with money.