September 18, 2013
By Sandra Boenig, AFC®, Military Saves Associate
I know that you are being bombarded with information about planning for your retirement. It can be crazy and confusing. So I am going to introduce you to two concepts that are great for any investment, including retirement. These concepts work even better if you start using them when you are young.
Dollar Cost Averaging
Dollar cost averaging is…….. Making regular contributions over time benefits you, because you can take advantage of investment value fluctuations. We don't know when the market will be up or when it will be down. With regular contributions you will sometimes get a bargain, and sometimes pay higher price, but in the end this can average out for you and you don’t have to try and time the market to get the lowest rates .
The Magic of Compound Interest
Compound interest is the idea that your money will grow over time and that small amounts saved now can grow to much larger amounts in the future. Let us say you have just joined the military and you signed up for TSP. TSP is a form of retirement savings. You can invest up to $17,500 per year into your TSP account. Below are two examples, one of a saver who savers early and one of a saver who doesn’t start saving till later.
If you save just10% of your gross pay ($200 for example) by transferring it to the TSP each month for 20 years you will have saved $48,000. But because you are receiving interest on that money (let’s say 6%), you will actually have $92,532 at the end of 20 years.
Waited to Save:
Now if you have been in the military 15 years and contributed nothing but want to start saving and try and catch up to the saver who started early you would have to save $48,000 over the next 5 years. But because you don’t have the magic of compound interest on your side you will not have the same amount of money as the person who saved young – even though you saved the SAME AMOUNT.
By contributing $800 per month for 5 years at a 6% return you will have saved $48,00 of your own money but will have only earned $7,891 from interest for a total of $55,891.
$44,532 is a lot more than $7,891, right? To have the same amount of money after 5 years as you would after 20, you would need to contribute about $16,000 per year. (For illustration purposes we assumed that your pay stays exactly the same and that your rate of return doesn’t fluctuate.)
Want to do your own calculations? Try this one on the TSP website
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