Retire on an Acorn

"The creation of a thousand forests is in one acorn, and Egypt, Greece, Rome, Gaul, Britain, America, lie folded in the first man."
-- Ralph Waldo Emerson

Believe it or not, you don't need all that much money in order to retire comfortably. You just need a little time. Permit me now to prove it, as I amaze and delight you with my mathematical prowess and the glories of compounded growth.

Let's say that you're 40 years old and are stressing out because you haven't saved all that much for retirement and fear it will all end up being quite gruesome. Let's also say that you have just $15,000 in funds that you can invest for retirement, and that you will invest it in a broad market index fund that has historically returned about 10% over long periods. Let's also say that now that you're finally buckling down, you (perhaps with your spouse) will also be investing an additional $10,000 per year. Here's how your nest egg will grow as you age:

The magic of compounding
It's useful to step back for a minute and appreciate the beauty of compounding. Note that each year, you're investing the same amount -- $10,000. And each year, your growth rate is assumed to be the same -- 10%. Yet during the five years from age 45 to 50, your nest egg grows by $124,378, while during the five years from age 70 to 75, it grows by more than $1.3 million! That's because as your money grows, each additional dollar starts earning additional dollars of its own. And those dollars also begin growing. It's a gorgeous loop.

What the numbers mean
OK, let's return to Earth now and to what you can get out of all this. Once in retirement, you'll have to live off that nest egg. How long will it last? Well, according to my favorite retirement information resource, our Rule Your Retirement newsletter (which you can and should try for free for an entire month, accessing all past issues), you should conservatively plan to withdraw about 4% of it per year in retirement to live on. (That sum should increase in step with inflation.)

So if you retire at age 65, 4% of your $1.27 million bundle will generate nearly $51,000 to live off in your first year. That may sound great, but remember inflation. Over 25 years, if it averages 3% per year, it will have increased prices by a factor of 2.09, making that $51,000 able to buy perhaps just $24,000 worth of goods and services. Still -- especially if your home is all paid for by that time, that $24,000 may still do a lot of good. But let's not stop here.

If you're 40 today, you'll likely retire at age 67 or even 70. At 70, your $2.1 million nest egg will kick out a 4% distribution of more than $84,000 -- considerably more, eh? Those five extra years of working can really pay off. (They'll help your Social Security payout grow, too -- assuming Social Security remains intact in a similar form.) Factoring in inflation, that $84,000 may be worth some $40,000 in today's dollars. That probably seems like a more reasonable sum on which to retire.

One last step. Let's say you hang in there until age 75. If so, your 4% withdrawal from $3.4 million will be $138,000, inflation-reduced to a value of perhaps $66,000! This may be more than you earn today!

And see? All from a little $15,000 acorn, a little annual fertilizer, and a lot of time.

More or less
Of course, that's just one example, and it doesn't fit all -- at all. Remember that:

• You probably won't earn exactly 10% over your investing period. It will likely be more or less, making your nest egg considerably bigger -- or smaller. Your age is also a factor. If you have more years for your money to grow, you can do better -- and vice versa.
• You can improve the situation by investing greater sums along the way (and remembering that the earliest investments are the most powerful, as they have the longest time to grow.)
• You can aim for higher than 10% by seeking out top-notch mutual funds and/or parking some of your nest egg in solid stocks. For example, over the past 20 years, stock in Wrigley (NYSE:WWY) has advanced an annual average of 18%, ExxonMobil (NYSE:XOM) shares have climbed 16%, and Abbott Labs (NYSE:ABT) about 14%. (Of course, Microsoft's (NYSE:MSFT) stock's rate during that period is about 32%, but you can see that many other companies can significantly boost your bottom line -- you don't need to hit the ultimate jackpot to do well.)

Take action!
So what are you waiting for? Start planning -- and investing -- for your retirement today, and it can make a world of difference. To inform and encourage you, I invite you to try (for free) our Rule Your Retirement newsletter, edited by Robert Brokamp.

Useful articles from past issues include the effects of inflation on retirement (along with tips on how to plan for it) as well as proper asset allocation and how to withdraw money prudently in retirement.

"Large streams from little fountains flow,
Tall oaks from little acorns grow." -- David Everett

Here's to big profits in your future!

Selena Maranjian owns shares of Microsoft. For more about Selena, view her bio and her profile . Microsoft is an Inside Value recommendation. The Motley Fool isFools writing for Fools.