On Becoming a Fearless Retirement Accumulator

Bear markets are bad news for investors whose primary goal is conserving their accumulated wealth. For investors who have yet to build a sizable nest egg, bear markets present opportunities. Stocks are on sale now at prices unseen since 1995. Equity markets could drop further, but if you plan to invest consistently over decades, whatever happens in the next year or two will have relatively little effect on how prosperous you are in 20 to 30 years. Here are three key concepts to creating a winning investment strategy for the accumulation phase of your life.

One: Start Early

Allow me to introduce you to the Saver twins, Joan and Jill. Starting at age 25, Joan puts $2,000 per year into her IRA. After five years and with $10,000 invested, she stops making contributions, but leaves the money in the account, where it earns 10%. Jill waits until she turns 35 to start her IRA, but keeps making contributions to the plan for 30 years. Who has more at age 65? The surprising fact is that Joan’s contribution of just $10,000, plus its earnings over forty years, has always amounted to more than her sister’s account, even though late starter Jill pumps $60,000 into her plan over thirty years.  Compound interest makes money saved when you are young much more valuable than funds saved at a later age. 

In this example, Joan’s contribution of $10,000 to her IRA becomes more than $300,000 by the time she turns 65. What if Joan doesn’t stop her contributions at age 30? Then she would amass more than $1,000,000 by age 65, assuming the same 10% return.  When you break it down, for someone with 40 years to do it, the cost of becoming a millionaire could be less than $6 per day.

Two: Create a Tax- and Cost-Efficient Plan

Controlling the costs of investing can be very rewarding over time. Let’s examine hypothetical cost differences between the Saver Twins’ retirement plans. Say that Joan and Jill both commit $10,000 per year to their 401(k) plans from ages 25 to 65. The only difference is that the fund expenses of Joan’s plan average 1.5% less than those at Jill’s company. If the return over the 40 years averages 8.5% for Joan, it would be 7% for Jill, assuming equal investment results. With 1.5% higher expenses in her plan, Jill would have a balance in her account at age 65 of $1,996,351, certainly nothing to sneeze at.  But Joan’s account balance would total $2,956,825, almost a million dollars more.  At higher rates of return the difference in amounts accumulated is even greater.

We all know that a million dollars just isn’t what it used to be, but I think we can probably agree that having an extra one or two million bucks would make a significant difference in the quality of life you enjoy in retirement.  Choosing less-expensive and more tax-efficient mutual funds within your 401(k) can improve the results of your savings program, ultimately producing a much greater accumulation of capital.

Three: Keep Your Balance

In our previous examples we assumed that the Saver Twins each have identical and uniform investment results. That’s a simplistic assumption, so let’s modify it. Say that, at the beginning of their savings program, they each decide to divide their money among four or five different types of funds for diversification. Jill never gives her allocation another thought and just lets the various funds in her account grow until retirement. Joan, however, calls the fund company once each year or two to buy and sell enough shares to reset the balances among the various funds to their original proportions. Guess what? Joan’s account outstrips her sister’s again. This time, it is the discipline of rebalancing -- regularly selling high and buying low that does the trick. Joan has captured the rebalancing premium.

Rebalancing is a good way to maintain proper diversification in your portfolio. You don’t have to worry about which asset class will be the top performer in any given year. You simply need the self-control to consistently respond to market changes in a way that protects you from big reversals and provides lots of small victories.

Now you know three things that can help you be the smarter twin. Start saving as soon as possible. Pay close attention to minimizing your costs. Keep your plan balanced.

What if you know you are too likely to act like the less attentive twin or are simply put off by the difficulty or bother of doing it yourself? Then consider hiring a financial planner to help keep you on track.

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