Compound interest: no math required!

If there's one concept you need to understand when it comes to saving and investing, it's compound interest.

Word people like me think of it this way: When you invest, your money earns a certain interest rate. And then your interest, as it's added to the pot, earns interest on itself.

Math folks think of it as a formula: 

Annual Deposit ([(1+Rate) ^Years+1 - 1]/Rate) - Annual Deposit = Total

Some financial types call it "The Eighth Wonder of the World." (Okay, maybe they need to get out a bit more.)

It doesn't matter what you call it, or whether you can do the math. In fact, a surprising new study from the University of California, San Diego and New York University, to be published in November, shows we don't need to know how compound interest works. But what we do need to know is that it does work—in a big way. The impact of compound interest is irrefutable and beautiful—it helps your money grow exponentially (aka HUGE, so long as you just let it sit and grow over time). Think of it like a sunset: You can appreciate its beauty without understanding the speed of light, right? Similarly with compound interest: you can appreciate the beauty of interest building on interest without being a mathematician.

If you're still having trouble grasping the power of compound interest, here's a quick example: If you were to save $1,000 a year from age 25 to 34 in a retirement account earning 8% a year, and never invest a penny more, your $10,000 investment would grow to $157,435 by age 65. But if you don't start saving until you're 35 years old and then invest $1,000 a year for the next 30 years (that's a total investment of $30,000), you'll have only $122,346 by age 65. The bottom line: Start early, so your money has enough time to pile up.

For now, I encourage you to try out the Compound Interest Calculator on MoneyChimp.com. (MUCH easier than the equation above!) Enter your current retirement contributions, estimate how much you'll put in each year and for how long, and—voilà—see an estimate of how much you'll have waiting for you. Not sure how much you'll need? Try the Ballpark E$timate calculator from ChooseToSave.org.

Once you have those numbers, think about your current retirement savings accounts. Ask yourself: Am I investing enough? Do I need to contribute more money? For newcomers who haven't even *thought* about retirement yet, use this as a push to get started. Enroll in a 401(k) or contribute more to it—even if it's just putting in 1% more of your salary. Think about opening an IRA (Individual Retirement Account) or adding $500 more to it this year than you did last year. Get in early and reap the benefits later—the not-good-at-math thing will just be between you and me.      



5 things women need to do for retirement

Happy 15^th anniversary to WISER—the Women's Institute for a Secure Retirement, for which I'm a board member. I'm so impressed with the work they do, and wanted to take a moment to spread the word, in hopes that ALL women will be financially safe and sound and able to enjoy their post-work lives! Need some motivation? Here are the top 5 things you should do, reposted from WISER's website. I urge you to start today!

 

1) Take charge of your retirement: Find out as much as you can. Talk to your spouse, find out about current and past employers, and check on your Social Security benefit. Even if you are worried about the answers, it's better to find out now than when you are ready to retire.

 

2) Take advantage of retirement benefits available at your workplace: Financial experts agree that there is no better place to grow money then at work because of the tax advantages. In addition, if your employer adds matching contributions, that's free money. The sooner you start, the longer the money will have to grow. Those over age 50 can take advantage of "catch-up" provisions that help you save more in your 401(k) and IRA plans. If you are lucky enough to have a traditional, defined benefit plan, make sure you understand why it is a valuable benefit.

 

3) Take time to educate yourself about Roth IRAs and mutual funds, long-term care insurance, and annuities: There is a wealth of information out there on the Internet, and WISER's website is a great place to start. Watch for free classes at local schools and seminars on public television, read magazines and articles on investing for retirement. Investing a little time along with your dollars can make a big difference in your retirement security. 

 

4) Take the first step to learn how much you will need to have a comfortable retirement:  The big question is whether your guaranteed sources of income, like Social Security combined with retirement accounts and savings will be enough for a comfortable retirement. Look at what sources of retirement income you can count on and what you can expect to receive from them.  Some of your expenses may go down, but others, especially health care costs, may go up significantly. Other factors include how long you will be retired, investment rates of return, and inflation. If what you have so far does not seem like enough, make a plan to save more.

5) Take the time to sound your own alarm. This is your wake-up call. Don't put it off:  Many women face challenges meeting retirement income needs, but educating yourself will help you choose savings and investment tools wisely.  Starting to plan now will give you more options later. The promise of retirement is having time for yourself after a lifetime of hard work.

Which step are you thinking about taking? Do you have any questions or concerns?

Workers: Good news ahead!

If you kept your job during the recession, you were considered lucky. But the daily grind didn't always feel so fortunate, since layoffs, salary freezes, and benefit cuts left the office pretty somber.

Luckily, spring is around the corner, and employees can look forward to two perks: raises (yes, you read that right) and new 401(k) features. Here's what you should know:

• Show me the money! Working hard may finally pay off again. Companies are budgeting merit increases of 3.0% for 2011, up from 2.7% in 2010 and the largest jump since before the recession when increases averaged 3.5 – 4.0%, according to a survey by professional services company Towers Watson. Note: These are merit-based, so the best way to qualify is to far exceed your duties, and then negotiate for the raise you deserve.

• Give me my 401(k)—with some goodies on the side.      I recently blogged about how experts are worried folks' 401(k)s won't even come close to covering their retirement expenses. To counteract this, many 401(k) plans are now offering new features like one-on-one counseling, Internet-based help, and toll-free telephone advisors to make sure people are saving enough. Whether these services will really get people to bulk up retirement funds remains to be seen. But at this point, anything's worth trying. Ask your HR contact if your company or 401(k) provider offers any of these extras—just asking may encourage them to look into it.

What good news are you seeing at the workplace?

Will your 401(k) be enough?

If you read my blog, you know I'm the biggest cheerleader for 401(k)s, since those lucky enough to get an employer match earn free money towards their futures. But right now, experts are worried that for many people, their 401(k) won't even come close to covering their expenses in retirement.

A new study shows that folks in their 60s with a 401(k) have less than a quarter of what they need to maintain their standard of living in retirement. And 25% of Baby Boomers have no retirement savings at all.Combined with fewer pensions and the shaky future of Social Security, this missing money leaves would-be retirees working more years, scaling back their standard of living, and postponing retirement 'til who knows when.

It's not a pretty situation. But remember: This is more telling of our economic times than it is of 401(k)s, and Boomers are suffering the most. For many of them, their 401(k)s plummeted in the recession and they haven't had enough time to rebound. Plus, as part of the 'sandwich generation', they're stuck between footing bills for kids' college and elderly parents' healthcare.

Point is, a 401(k) is a wonderful savings tool, if you know the right way to use it:

• Start ASAP. The younger you start, the more years your money will have to grow thanks to compound interest. Say you make $50,000 and contribute the expert-recommended 12% each year. After 40 years you'll have nearly $1.4 million, but if you start later and invest for 20 years, you'll have only $286,000. BIG difference.

• Go up a notch. Many folks contribute the minimum to their 401(k), often 6% of their annual salary to get their company's 3% match. Now, experts recommend you contribute 10-15%. It may mean cutting back in other ways, but it's easier to be thrifty now than poor in old age. And, if you're 50+, you can contribute an additional $5,500 beyond the $16,500 annual limit—do it.

• Save beyond a 401(k). Consider opening or contributing more to an IRA. Or try saving just $3 a day ; if you invest it in an IRA, it could be worth hundreds of thousands of dollars when you retire.

• Calculate correctly. It's easy to underestimate (or have no idea) how much money you'll need to in retirement. A common measure is that you'll need 85% of the salary you earn before retirement.  Or, to get an actual figure, try this formula from human resources consultant Aon Hewitt, who says Boomers 46-54 will need 14.6 times their final salary, folks 31-45 will need 16 times, and those 18-30 will need 18.7 times.

• Have faith. At the same time this study came out, Fidelity reported that the average 401(k) account balance hit a 10-year-high. Kudos!

How are you preparing for your retirement?

The R Word

To some, retirement is a dirty word. It may be hard to imagine yourself as a senior citizen because it feels so far off. Or the idea of saving for retirement may be just plain overwhelming. But now's the best time to get started. It's a new year, and employers are ready to help: 39% have restored their retirement plan matching programs and 38% plan to restore it in the next six months (translation: free money).

I know it can be tempting to put off saving for retirement. Believe it or not, at my first real job, I didn't participate in my 401(k) plan right away! I'm sure I had a good excuse at the time, but nothing could justify the thousands of dollars I've lost in the long-term. If you're still not convinced, here are a few things to consider:
 

1. You cannot borrow for your retirement. Getting by on credit cards might work just fine today, but, eventually, you'll need to have some savings.

2. More than 3 million American senior citizens live in poverty. And 71% of them are women, who, on average, have 40% less in retirement accounts than men, even though they live four years longer.

3. It's not selfish to put yourself first! There's no better gift to your family than not having to lean on them when you're older. Consider this your permission slip to invest in your own retirement before stocking your kids' college funds.

Plus, saving for your future can be as simple as saving just $3 a Day. Start this week, and by the end of the year, you'll have over $1,000 saved. A 35-year-old who follows this plan and lets the funds grow in an IRA could have more than $125,000 stockpiled by age 70.

What got you to finally start saving for retirement?