By: Dividend Sensei
As you can see the amount you’ll need to save each month is both exponentially smaller, and inversely related to your time horizon. What might be impossible with zero savings and a five year horizon becomes extremely easy if you start early enough.
But this brings us to the third and possibly the most important part of knowing yourself, which is what kind of investor are you? By which I mean are you in wealth growing mode or in wealth preservation mode? If you don’t have enough for retirement currently then whether you like it or not you are in wealth growing mode and that means that the biggest investment risk of all is not taking enough risk. Or to put another way if you think you can save and invest your way to a prosperous retirement through bonds, CDs, or savings accounts you are sadly mistaken.
For example between 2004 and 2014, a period that included the market’s 55% plunge between 2007 and 2009, the S&P 500 managed to deliver 8.11% annualized total returns. Bonds as measured by the Barclays U.S. Aggregate Bond Index delivered 4.62% annual returns. And keep in mind these were nominal returns. Inflation during this 10 year period averaged 2.4% per year, meaning that the stock market’s real returns were 5.7% per year, far below the 7.0% historical inflation adjusted average. However bonds delivered just 2.2% growth. That means if you were investing heavily into “safe” bonds then you might end up never retiring at all. The bottom line is that if you want to acquire enough money to retire comfortably, unless your income is enormous, you’ll need the stock market to do it.
But what if you are fortunate enough to already have a large enough nest egg? Or perhaps you have a company pension that will augment your social security and thus you don’t actually need $725,000 (per person) to retire? Well then you’re in wealth preservation mode, which leads me to my fourth risk management rule. One that’s even more important than the three we’ve already explored and which is the subject of the next article in this series.