There’s an interesting article in Financial Planning magazine that confirms mathematically what most people know intuitively.
First, the earlier you start saving for retirement the more money you’ll have.
Second, the younger you are the more risk you can take to generate a higher rate of return.
For an investor who begins contributing to an investment portfolio at 25, the baseline terminal value at 65 is $528,007. If the annual portfolio return increases to 10% and the savings rate stays at 6%, the portfolio value at 65 soars to nearly $1.4 million. On the other hand, if the savings rate increases to 10% a year and the portfolio return stays at 6%, the ending portfolio value at 65 is $880,012.
Third,as you get nearer retirement, the amount of money you put aside is more important than the rate for return on that money.
For an investor who starts saving at age 55, raising the savings rate to 10% of income produces an ending account value that is nearly $40,000 higher than if the portfolio return is raised to 10%. Clearly, this is an investor who is very late to the game …. Such investors need to do all they can to prepare for retirement. These results clearly indicate that saving as much of their income as they can has a greater impact than cranking up the portfolio risk to try to generate higher returns.
Another, related issue: Contributions are a variable that is more in the control of the investor, while portfolio performance, particularly in the short run, is far less controllable. As a result, investors who rely upon portfolio performance to do their heavy lifting will usually fall into the trap of having too much equity exposure and, therefore, too much risk.
Particularly for clients who are in or near retirement, the performance of an investment portfolio should accomplish two primary goals: preserve and protect principal and provide a modest rate of return.