It is quite easy. All it takes to understand this concept is a little arithmetic.
In financial planning we spend a lot of time talking about savings. In order to build a portfolio, you have to save a small part of what you earn.
For many there is not enough money at the end of the month to save. An entire paycheck seems to disappear.
On the other hand, most people have enough disposable income for a daily treat and that is often a cup or two of coffee.
It’s very easy to spend seven dollars a day on your coffee treat. What would that seven dollars a day grow to if it was invested?
Assume an 18-year-old started to save seven dollars a day until age 65.
With inflation, things cost more every year so I will also assume our saver increases their saving amount by three per cent per year.
Another assumption is that the annual return on investment is eight per cent.
At age 65 our coffee drinker would have accumulated just under $1.8 million. Then I will assume an equal amount was withdrawn every year to provide for retirement spending for the next 25 years.
In the first year of retirement, the money withdrawn would be $120,000 per year. The withdrawal amount would grow three percent per year to keep peace with our inflation assumption and the final withdrawal, at age ninety, would be $250,000.
Yes, our coffee drinker is a hypothetical example where I make assumptions, but the main take-away is the effect that even a moderate savings plan can have over the long-term.
Can’t give up your java? Take a look at a typical day’s expenses and check for ways to trim the spending by a few dollars.
My suggestion is to start a savings plan, and the younger you start the better.