Have you ever wondered how much you really need to retire? Chances are, if you’re approaching retirement, you probably think about this often. Thinking about it often and understanding how much you need are two very different things.
Understanding how much you need to save is challenging because the equation isn’t straightforward. Money grows over time through a concept called compounding.
Here’s an example to illustrate this:
Compounding Is A Snowball Rolling Down A Mountain
Think about your investment as a snowball at the top of the mountain. The size of the snowball represents the amount your investment is worth. The bigger the snowball, the larger the value.
The mountain is time. As the snowball rolls down the mountain, time is passing. While your snowball is rolling down the mountain, it begins to collect more snow and it grows.
How The Snowball Grows
As your investments grow, you are able to generate money from them. This can be in the form of interest payments, something called dividend payments or the actual value of the investment - the price you could sell it for - increases.
You can earn interest and dividends and the value of investment increases. In other words, it’s possible that one, all or a combination of these things can happen to grow your investment.
Back to the snowball rolling down the mountain. As it’s collecting more snow and growing, your investment is paying you in interest and/or dividends. As the snowball grows, it becomes larger. A bigger snowball is able to attract more snow because of how big it is. The surface area keeps increasing, making it possible to attract more snow and grow exponentially.
That’s the magic of compounding interest. As it rolls (as time passes) it grows and grows and grows. By the time your little snowball reaches the bottom of the mountain, it’s grown to be a giant snowball of retirement cash - well, that’s the hope.
How to Calculate How Much to Save
Now that you understand how investment and retirement savings works, what you need figure out is how much to save. The amount you save is a factor of your current income now. The assumption is that you want to have a lifestyle not radically different than the one you're living today.
There's no way to predict who you will be in the future, what your interests are and the lifestyle you'll want to be living - so keep that in mind. But also keep in mind if you're spending a bunch of money on things you don't need, now would be a good time to start addressing that. Remember that projections are imperfect. We do the best we can with what we know, but we don't know everything.
Use the retirement calculator on our website to help you calculate how much you'll need in retirement and how much you should be saving each month.
The Bigger The Mountain The Better
We’ve all heard that one ought to start investing early and invest often. The underlying rationale here is if the snowball has a long way to roll down the mountain, it has a better chance of accumulating a lot of snow. And if you keep adding to the snowball, you help it grow so it can attract more snow.
