In life, there are so many things that are out of your control. Although you may do your best to be prepared for what life throws your way, every day is full of surprises. When it comes to your financial well-being, the best thing you can do is prepare a financial plan that puts you on the path to early retirement and a life of prosperity and happiness. Unfortunately, planning for your future is something most Americans just ignore. We want to live in the moment and worry about the consequences later on. With this kind of mindset, the impact of your prior actions always seems to hit you at the worst time.
Let’s take a look at how living in the moment and purchasing whatever you want can wreak havoc on your future. As we most know, your priorities when you’re younger normally don’t include planning for your retirement. And although that’s fine, it shouldn’t be too far down the list of objectives that require your attention. But once you hit your late 40s to early 50s, you all of a sudden realize that you’re nowhere close to having the necessary savings to retire early. To mitigate the savings gap, most people decide to work longer and retire later than planned. Of course, this approach has some potential pitfalls, but it’s still one of the most common options people choose.
The other option, which is extremely dangerous, is to make up the shortfall in savings by choosing to become an aggressive investor. And since there’s no such thing as a free lunch, we know that pursuing higher returns always translates into higher risk. It’s imperative you understand that your ability to consistently select investments that outperform the market is something that even most seasoned professional money managers can’t do. If we’ve learned anything over the past decade, it’s that the market is unpredictable and annual investment returns, especially in high-risk investments, is out of your control.
What is in your control is your ability to spend less and save more. To better illustrate my point of focusing on what you control, let’s look at two investors (investor A and investor B) as shown in the table. Each investor is currently 30 years of age with a goal of retiring at 50. They both have $100,000 in current savings with a goal of having a retirement nest egg of $500,000 by the time they retire. The only difference is that investor A focused on what he controlled and saved $300 a month for the next 20 years. Investor B decided that saving a small amount like $300 would be meaningless and decided to spend the money and shoot for a higher investment return to make up the difference of not saving. On the surface, you’re probably thinking the same thing as investor B. I mean, how much higher would your annual investment return have to be to make up for a paltry $300 a month? The answer below may surprise you.
Are you surprised at the annual rate of return that investor B (8.4%) must earn for the next 20 years, which by the way is 33% higher than the annual return investor A (6.3%) has to achieve? In order to achieve an annual return of 8.4%, what kind of investments would investor B have to purchase? More importantly, what are the chances of investor B making an annualized return that only a handful of professional money managers have achieved over the last 20 years? As for investor A, an annual return of 6.3% is reasonable and can be achieved by investing in a conservative mix of big-name dividend-paying stocks and high-quality bonds.
In a nutshell, it’s truly amazing what a small sacrifice can do for your long-term financial future. By focusing on what you control and saving a little bit now versus spending every nickel you have, the odds of successfully achieving your retirement savings goal increases considerably.