One thing that many people worry about with retirement is outliving their savings, and it's not because they think they'll live well into their 100s -- it's because they don't think they'll have enough saved. One way to put yourself in a position to retire comfortably is by understanding the power of compounding. Once you realize just how powerful compounding is, you'll see that time is your best friend and can do a lot of the heavy lifting for you.
Don't believe it? Just check out the below table, which shows the hypothetical value of $1,000 monthly investments that return, on average, 10% annually until age 65.
| Starting Age | Years Until 65 | Principal Invested | Account Total |
|---|---|---|---|
| 25 | 40 | $480,000 | $5.31 million |
| 35 | 30 | $360,000 | $1.97 million |
| 45 | 20 | $240,000 | $687,300 |
| 55 | 10 | $120,000 | $191,200 |
Data source: author calculations.
This is the most important retirement table you'll likely ever see. Not because of the specific figures -- those will vary based on how much you invest and your returns -- but because it illustrates just how important a role time plays in growing your wealth.
Notice that beginning at age 55 versus 45 results in just over a $490,000 difference; starting at age 45 versus age 35 results in just over a $1.28 million difference; and beginning at age 35 versus 25 results in a $3.34 million difference. Even though the difference in the principal invested between the time increments is the same $120,000, the gap between the end results widens as the time horizon grows longer.
Image source: Getty Images.
Figuring out how much you'll need
It becomes easier to save for retirement when you know exactly how much you'll need. Unfortunately, there's no universal answer as each person will inevitably have different lifestyles and expenses. There are, however, rules of thumb you can follow to give you a good baseline. For example, start with the 80% rule, which encourages retirees to aim to generate 80% of their annual preretirement income.
Once you have this number, you can use the 4% rule to give you an idea of how much total you should aim to save. The 4% rule says retirees should plan to withdraw 4% of their savings each year for 30 years (adjusting for inflation) to avoid outliving their savings. You can calculate this total by multiplying your target annual income by 25. For example, if you currently make $80,000, you would aim to have $64,000 annually in retirement. Multiplying $64,000 by 25 gives you $1.6 million, your savings goal.
Investing shouldn't be optional
Many people will find they need $1 million or more saved for retirement, and while not impossible, that's a very hard goal to reach simply by setting money aside in a savings account. Even if you have 40 years to do so, that would require $25,000 each year -- a tall order. But you can invest to ease that burden. Many younger people put saving and investing on the back burner, because retirement is decades away, but small investments with more time can go further than large investments with less time.
Even if you only invested $200 monthly over 40 years with a 10% average annual return, you can accumulate over $1.1 million while only putting $96,000 of your own money into the portfolio. Someone who bumps their monthly contribution to $2,000 but only has 15 years would only manage to save about $400,000 while personally on the hook for $360,000 of that. As you can see, time and consistency are key to setting you up financially in retirement.
