Tuesday, October 23, 2012

30-Somethings Retirement INSECURITY, Compounding, Time in the Market and the "Last Double"

In a new survey, 30-somethings are revealed as the age group most concerned about having enough money for a secure retirement, replacing the baby boomers as the ones most troubled about our nation's precarious financial situation. To me that's a good sign.

Retirement worries grow; 30-somethings most uneasy has the story:

"Younger Americans in their late 30s are now the group most likely to doubt they will be financially secure after retirement, a major shift from three years ago when baby boomers nearing retirement age expressed the greatest worry.... 

As a whole, retirement worries rose across all age groups — roughly 38 percent of U.S. adults say they are "not too" or "not at all" confident that they will have sufficiently sized financial nest eggs, according to the independent research group. That's up from 25 percent in 2009.

But the concerns are increasing the greatest among younger adults approaching middle age, whose equity in their homes represents most of their net worth. About 49 percent of those ages 35-44 said they had little or no confidence that they will have enough money for retirement, more than double the 20 percent share in that age group who said so in 2009.

Baby boomers born between 1946 and 1964 also reported having more retirement anxieties than before, but now to a lesser degree compared to their younger counterparts. About 43 percent of Americans ages 45-54 expressed little or no trust in their retirement security, up from 33 percent in 2009. Among Americans ages 55-64, the share expressing little or no confidence was 39 percent, up from 26 percent.

Broken down by smaller groups, the Pew analysis found that retirement worries peaked among adults in their late 30s; a majority, or 53 percent, of Americans ages 36 to 40 lacked confidence that they will have large enough nest eggs. Just three years ago, it was baby boomers ages 51 to 55 who had the most anxiety over whether their income and assets would be sufficient."


Let's discuss this now.

In my oldster generation, we weren't much worried about retirement income. We should have been.

As a result, younger people today are absolutely right to be concerned. They'll have to pay for a large portion of our generation's Social Security and Medicare benefits while providing for their own at the same time. It's a shame, but it's also the plain truth of the matter.

So younger people are concerned about having enough money for their retirement years and rightfully so. Let's try to shed some light on the subject so that we at least will know what needs to be done. Whether the younger folks in fact later carry out those good intentions, of course, will be up to each of them.

So let's go over the importance of following the simple rule of 72 when investing and building assets over a long period of time.

The rule of 72 may not be one of the seven wonders of the world, but a proper understanding of compound interest unquestionably deserves a place at least among the top ten. At least that's my view.

So let's look at this from the point of view of a man named Steve and how he ended up with only one half of what he thought he should have had in his investment account at retirement.

How to make the most of compound returns is subtitled 'Time in the market works, but big deposits help:

"This is a story of incredible wealth generation and why many investors are missing out on it.

It started with a recent column in which the math wasn’t working for Steve, a reader in Seattle....

What Steve couldn’t fathom, however, was why his results weren’t nearly what the column suggested they should be. Read previous column about Vanguard Health Care.

Vanguard Health Care had turned a $10,000 investment into about $310,000 in the past two-and-a-half decades, but Steve’s portfolio had grown to only slightly more than half of that. While he started with less than $10,000, Steve figured he had crossed that threshold in 1990; all dividends and capital gains had been reinvested and he had never withdrawn a cent....

Was it simply unfortunate timing? Was it that he’d started with less than $10,000? Was it that he didn’t make IRA contributions to the account every year? Was it bad record-keeping, bad math by the columnist or something more nefarious?

“Sure there were differences from the $10,000 all being invested in 1987, but to have that be the difference between roughly $300,000 I thought I should have — based on the returns shown in the article — and the $160,000 in my account didn’t make sense,” Steve said.

Alas, the difference was completely logical, and it showcases one of the biggest blunders investors make, because it is a lesson in the magical power of compounding.

Steve thought he opened the account with several thousand dollars, but further reflection showed it was $1,000 . . . .

Even with a second contribution in 1987 and some solid growth by the fund, he was less than halfway to the $10,000 example starting point when the 1987 market crash occurred.

While his continuing contributions helped him to play catch-up, the lower starting point effectively cost him one “double,” or the period of time it would take for his account to double in size.

Start with the Rule of 72 (take 72, divide it by the rate of return and you will see how long it takes for an investment to double) and an annualized return of 14.5% — roughly the fund’s performance for the last 25 years – and you see that an account would double in size every five years. 

Thus, in 25 years, an investor gets five doubles, turning $10,000 into $20,000, then $40,000, $80,000, $160,000 and on up to roughly $320,000.

If Steve started the same period with roughly $5,000 on account, his five doubles leave him with roughly half the cash at the end, when the doubles turn a small difference into a big one.

There’s no “missing” money; he never deposited some of it, so he didn’t earn the rest of it.

“It seems like such a small difference, but when you see how big that difference is at the end, it really makes me wish I had found a way to do more when I was younger,” Steve said.

There’s an investing adage about how “it’s not about timing the market, but about time in the market.” Ironically, Steve did both well; he bought the best fund of his generation, gave his money to the best manager of a generation and let it ride.

Perfect timing and plenty of time, just not enough cash. . . .

Today, Roger Ibbotson of Zebra Capital Management — whose market-history studies of the past convinced many people that stocks should return 10% per year — says the next 25 years will bring lower average returns. Slower growth coupled with lower deposits is a recipe for starting small and staying that way.

The market slows the pace of the doubles; lower deposits exacerbate the problem.

At a time when many investors are scared enough to be on the sidelines, or looking for the exit, or mulling how they might benefit from avoiding the next downturn, the market’s less-rosy long-term outlook should instead be pushing them into investments that will capture the trend for the next 25 years and beyond, making the most of the market’s compounding power."

Summing Up

What a difference to our financial security and well being in retirement that last double makes!

And that explains in crystal clear terms the 'magical' rule of 72. While perhaps an oversimplification, the rule makes the not always obvious point that the more we invest and the earlier we invest, the more we'll have at the end of the line.

Two things are paramount: (1) Getting started in investing in earnest at the outset of our working lives and and (2) that last double are what matter the most.

While average annual  returns make a huge difference, of course, they don't mean as much as that last double.

In other words, $10,000 invested for 45 years at an average annual return of 8% grows to $320,000.

But $10,000 invested for 27 years at 8% will only accumulate to $80,000 whereas at 36 years it would reach $160,000 and in 45 years will hit the aforementioned $320,000 level.

Thus, good advice is to start investing as early as possible, continue to invest regularly, stay with stocks, and take what the market gives you by holding down or eliminating investment advisory fees.

However, the best advice of all is to familiarize yourself with how following the rule of 72 will bring you surprisingly strong results at the end of the road to retirement.

And unlike Steve, pay attention to that initial starting point and that last double.

It's really that simple.

Thanks. Bob.

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