The Tried and True Method Of Retirement Savings
In this blog I haven't accounted for inflation. I did this to keep this process as simple as possible. This method will still work once you account for this.
How many times have you taken advice from a friend, family member, professor, or "expert" only to find out they gave you tips that were completely wrong? This is the importance of doing your own due diligence on topics that you’re interested in or want to learn about. All it takes is one person to send you on a journey in the completely wrong direction for years or even your whole life. We don't like to sometimes admit the influence that each person we come in contact with has on our lives but this is the importance of fact-checking information that we choose to listen to.
This brings me to my story: I was in my first semester of business school. The class was Introduction to Finance. We were on the topic of retirement and how much money you really need to retire comfortably. My professor brought up how $750,000 wasn’t enough to retire in today's society because if you were to withdraw $50,000 out of your retirement account each year starting at age 60 you would run out of money by 75. The point he was trying to make was that the average person would outlive their money. While my professor was partially correct about this, he was missing the most important aspect of retirement savings: compound interest. You see, you can only take advantage of compounding interest if you have your money inside an investment account. Evidence shows that you can yield 10%+ average returns year after year on your investments when you invest your money in a low cost index fund following the S&P 500. You might ask, “What is the S&P 500?” In short, the S&P 500 represents the growth of the top 500 businesses over each year.
If my professor used this method and invested in the S&P 500 he would have been able to save far less money in order to reach $750,000 and his money would have given him - on average - a return of $75,000 each year. This would be possible without
him ever having to touch the original $750,000 he generated over the course of his life, meaning he would never outlive his money and he would also have that money to leave to whomever he chooses once he passes.
Don’t believe me? Lets run some numbers: Say hi to friends and colleagues Terry and Keisha. Both will make around $60,000 a year from ages 20-60 and both have hopes to retire by age 60. While their yearly earnings and spending habits are the same,
the difference is that Terry doesn't believe in investing so he keeps his money in a normal savings account while Keisha does believe in investing and so she opens up an investment account and invests in a low cost index fund (along the S&P 500, as I’ve mentioned earlier) that yields - on average - 10% interest a year. While saving for their retirement both of them never miss a payment of $300 a month into their savings accounts. You might be thinking they are both going to have the same amount of money at retirement because they’re
saving the same amount each month. Wrong. Terry at age 60 has $144,000 while Keisha has made a whopping $1,665,104.44 A staggering 1100%+ more than Terry. This is the power of compounding interest. Keisha’s investments will yield her $166,510.4 a year at retirement; that is more than Terry saved his entire life. Keisha will make an average of $166,510.04 based on earnings of around 10% each year for the rest of her life and she doesn't need to even touch the $1,665,104.44 principle. She can instead leave that to whomever she wants when she passes away. Terry has less than three years of income if he pulls out $60,000 a year and nothing to leave for his family. This is the importance of financial literacy as I have said in my previous blog.
I understand this blog has a lot of information to take in so I will give you a break down of the step-by-step process to starting your savings or retirement journey early. People who start retirement savings in their 20's will have a significant amount more at retirement than someone who starts in their 30's. If Keisha started her retirement at 30 instead of 20 she would have had $618,852.99 rather than $1,665,104.4, saving $300 each month. Still impressive buts that's a staggering 60%+ difference.
The information I'm about to give you is the method I'm using to save for retirement. By no means should you blindly follow and do the same thing! You MUST do your own research and form your own opinion before you ever enter the market.
1.) Open a TFSA - Tax Free Savings Account. You can do this online Via QuestTrade or at your bank. The minimum starting Balance usually ranges between $500-$1500 to open and typically takes 3 weeks.
2.) Use the Compound Interest Calculator I have posted below to estimate how much you would need to contribute over a given time or up front to reach your goal.
3.) Do your DD - Due Diligence - and choose what Index fund is right for you. I will list the top funds below that have a track record of great year-on-year returns.
4.) Buy and Increase your position each year according to your goals. You should know how much you must contribute to reach your goals if you followed step 2 correctly.
5.) Ride the winning years and don't let your emotions get the best of you. During down years you’re in the market for the long term and the market always produces positive
results over the long term.
Compound Interest Calculator:
https://investor.vanguard.com/etf/profile/VOO <--- My Top Pick