Time Can Be a Strong Ally in Saving for Retirement

Father Time doesn't always have a good reputation, particularly when it comes to birthdays or athletic prowess (unless you’re Tom Brady or LeBron James). However, when it comes to saving for retirement, time might be one of your strongest allies. Why? When time teams up with the growth potential of compounding investments, the results can be extremely powerful.

Time and money can work together

The premise behind compounding is fairly simple. Your retirement plan contributions are deducted from your paycheck and invested either in the options you select or in your plan's default investments. Your contribution dollars may earn returns from those investments, then those returns may earn returns themselves — and so on. That's compounding. Sometimes this is referred to as the “Snowball Effect.” The earlier you start, the stronger compounding is.

Compounding in action

To see the process at work, consider the following hypothetical example: Say you invest $1,000 and earn a return of 7% — or $70 — in one year. You now have $1,070 in your account. In year two, that $1,070 earns another 7%, and this time the amount earned is $74.90, bringing the total value of your account to $1,144.90. Over time, if your account continues to earn positive returns, the process can gather steam and add up. The power of compounding is even more pronounced with larger investments.

Now consider how compounding might work in your retirement plan. Say $120 is automatically deducted from your paycheck and contributed to your plan account on a biweekly basis. Assuming you earn a 7% rate of return each year, after 10 years, you would have invested $31,200 and your account would be worth $45,100. That's not too bad. If you kept investing the same amount, after 20 years, you'd have invested $62,400 and your account would be worth $135,835. And after just 10 more years — for a total investment time horizon of 30 years and a total invested amount of $93,600 — you'd have $318,381. That's the power of compounding at work.

Keep in mind that these examples are hypothetical, for illustrative purposes only, and do not represent the performance of any actual investment. Returns will change from year to year, and are not guaranteed. You may also lose money in your retirement plan investments. However, that's why when you're saving for retirement, it's important to stay focused on long-term results. Day to day returns become insignificant when your time horizon is decades long.

These examples do not take into account plan fees, which will impact total returns, and taxes. When you withdraw money from your traditional (i.e., non-Roth) retirement plan account, you will have to pay taxes on your withdrawals at then-current rates. Early withdrawals before age 59? (age 55 or 50 for certain distributions from employer plans) may be subject to a 10% penalty tax, unless an exception applies. Nonqualified withdrawals from a Roth account may also be subject to regular income and penalty taxes (on the earnings only — you receive your Roth contributions tax free).

Stick to your strategy

To capture all the benefits of compounding, try to resist the impulse to change your investment strategy with every news headline or investing tip from a relative or coworker. Timing the market correctly is very difficult; even professionals find it a challenge. Most people fare better by having an investment game plan that can weather good times and bad, and then sticking to it.

That doesn't mean you should simply forget about your investments altogether. At least once a year, you should review your portfolio to see if your choices are still appropriate. Even if your circumstances haven't changed, market movements can affect how your money is divided among various types of investments. For example, if one type of asset has been very successful, it may now represent too large a share of your holdings. To rebalance your portfolio, you could sell some of an asset that's now larger than you intended and buy more of a type that is lower than desired. Or you could keep your existing allocation but shift future investments into an asset class you want to increase. But if you don't review your holdings periodically, you won't know whether a change is needed. I like to call this “trimming the flowers and watering the weeds.”

A colleague once told me a perfect analogy: “Investing is like a bar of soap. The more you touch it, the smaller it gets.” After all, Father Time is undefeated, but not always in a negative way. Start investing now, your retirement depends on it.

CNB Wealth Management’s team of trusted advisors and CERTIFIED FINANCIAL PLANNER professionals are here to help you stick with your strategy and guide you through your retirement journey.

Our team at CNB Wealth Management is here to answer any retirement or financial planning questions you may have.