Outside the Box: Saving for retirement? Here are four key lessons

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If you’re saving money for retirement, there are four important lessons I hope you’ll learn. I’ll back them up with some numbers.

These may not be new, but they will be crucial to your success.

Lesson 1: When you start saving, the amount you invest will make more difference than your choice of investments. (This assumes you’re not trying to take chances on individual stocks or commodities.)

After 10 years of steady savings, the majority of the dollars in your account likely will be dollars that you put in, not dollars you earned. But if you let this lesson discourage you, you’re flirting with failure. Long-term investing works only if you keep going.

Lesson 2: Like it or not, luck will play an important part in how successful you are. This applies to good luck as well as bad luck.

If you begin saving money near the start of a strong bull market, you’ll feel confident. But if the market goes into a painful downward slide just as you’re getting started, a bear market might make investing seem pretty stupid. (Hint: It’s not.)

Lesson 3: Over the longer term, your choice of investments has an enormous impact on your ultimate success. The good news is that we know a lot about what worked well in the past. The bad news is that we know nothing about what’s going to work well in the future.

Lesson 4: Despite all that, there is one surefire way to do better when you’re saving for retirement: Save more.

I’ll show you some numbers based on assumptions of somebody saving $ 1,000 a year. In every case, if you saved $ 1,500 a year instead, you’d have half-again as much in the future.

If you can do this for 30 or 40 years, depending on how much you save, your choice of investments — and that all-important factor of luck — that extra 50% could add millions of dollars to what you have when you retire.

The numbers I’m going to cite come from some tables available on my website. They show actual year-by-year returns and results from 1970 through 2020 for portfolios with various combinations of stocks and bonds.

They all assume an investor added $ 1,000 a year ($ 83.33 a month) in 1970, then increased the contribution by 3% every year to cover presumed inflation.

Let’s loop back to Lesson 1. As you can see in Table 73, if your monthly investments all went into the S&P 500 SPX, +1.09% in 1970, you ended the year with $ 1,022. That $ 22 gain wasn’t very impressive!

If you continued that plan for 10 years, your contributions totaled $ 11,465. At the end of 1979, your account was worth $ 16,270. Did that make you feel you were on the way to becoming a millionaire? Probably not.

The majority of that year-end balance, about 70 cents on the dollar, came from your own pocket.

In the second decade of your plan, you added an additional $ 15,408. Your year-end balance in 1989 was $ 120,320, giving you a gigantic payoff for sticking with the plan.

Of that total, just $ 26,873, or about 22 cents on the dollar, came from you. The rest was what you earned.

Fast-forwarding another 10 years, you ended 1999 with $ 703,515. Your total contributions at that point were $ 47,599, or 6.8 cents on the dollar.

This shows the value of being patient and continuing to add to your account.

In other columns in the table you’ll see results for portfolios that were less equity-centric. And of course you can follow the numbers another 21 years through 2020.

Let’s revisit Lesson 2, the importance of luck. The decade of the 1990s saw the value of your portfolio balloon from $ 120,320 to $ 703,515. Your own contributions accounted for only $ 20,726 of that $ 583,195 increase in value.

That was Lady Luck at work, as the last half of the 1990s included a roaring bull market for the S&P 500.

But luck — this time bad luck — played a big role in the following decade, with two brutal bear markets that drove many investors out of the market.

Assuming you continued to contribute monthly according to the plan, you added another $ 27,825. Yet your portfolio ended 2009 worth only $ 668,733. Though that was a startling loss, over three decades your portfolio did very well for you.

To illustrate Lesson 3, I suggest you scroll down to Table 76a, where you’ll see year-by-year results for investing in the four asset classes of the Worldwide Four-Fund Combo portfolio that I described in a recent article.  

Based on the exact same contributions of $ 1,000 a year, this four-fund strategy would have resulted in a balance of $ 25,611 after 10 years (vs. $ 16,270 in the S&P 500) and of $ 254,317 after 20 years (vs. $ 120,320).

The enormous bull market in U.S. stocks in the 1990s, greatly favored the S&P 500, which ended 1999 with a value of $ 703,315 after 30 years of investing. But the four-fund combo was still ahead at that point, worth $ 724,586.

The diversified strategy really bloomed in the first decade of this century, ending 2009 worth $ 1.35 million — twice the value of the S&P 500.  

A bonus lesson: You never know what’s coming next. That’s one reason why diversification is so valuable. And why you “know” less than you think you do about the future.

Still, even though we can’t know what’s just over the horizon, in the long run the market has always come back and resumed an upward trend. Will that continue? There’s no way to know for sure. But there’s also no viable long-term alternative that I know of.

If you put these four lessons to work, your chances of long-term success are high.

For more thoughts on saving for retirement, check out my podcast.  

I also invite you to virtually attend one or more of four live events coming up this month in the Financial Education Series sponsored by the Bainbridge Community Foundation.

Richard Buck contributed to this article.

Paul Merriman and Richard Buck are the authors of We’re Talking Millions! 12 Simple Ways To Supercharge Your Retirement.