Friday, August 8, 2008

The importance of investing for retirement as early as possible

At the beginning of the 21st century most young people are told that social security won’t be there for them when they retire from the work force. Thus, in order to be able to completely retire from the workforce, a person has to invest as early as possible in order to take full advantage of the power of compounding.

Let’s follow the story of Erica and John. They both grew up on the same street in the same city. Their mothers gave birth to them at almost the same time. Erica and John went to the same high-school, after which their paths separated. They lost contact with each other for the next 40 years, at which point they found each other on Facebook, and met to reminiscence their childhood and talk about grandkids.

They quickly started talking about their retirement and the amount of money they had each had at the time of their retirement. John, who always saved the extra money he earned from jobs at college and his first job after college, started investing $2000/year in dividend stocks starting at the age of 18 and kept saving and investing the same amount until he was 28. At that point he had so many expenses in order to pay for the needs of his growing family that he couldn’t save anymore. Despite the fact that John couldn’t contribute any more to fund his retirement, he was very good at picking solid dividend growth stocks, and was able to generate annual returns of 10% for the next four decades.

Erica on the other hand had decided that she didn’t want to work in college since she wanted to concentrate on her studies while also enjoying the whole college experience. She then decided to go ahead and get a masters degree after which she was able to get a very good job with one of the largest companies in the USA. She did accumulate a large amount of student debt in the process, which she diligently paid off in a record time after she got her first job. After learning about the importance of saving for your own retirement, she started investing $2000/year in dividend stocks, and was able to also generate 10% in annual returns.

We then fast forward to the age of 65. At age of 65, John's net worth is 1,192,257.81. Erica's networth is $728,086.87 at the age of 65. 

Despite the fact that John had invested only $20,000 in total, versus $76,000 that Erica had invested, he was able to achieve a higher amount of wealth because he had taken a full advantage of the power of compounding by investing his hard earned money as early as his freshman year in college. Even though Erica contributed money for over 37 years her nest egg was $400,000 lower than John’s, because she had ten years less to utilize the power of compounding. You could also access the spreadsheet from here. 

The most important point from this exercise is: start investing for your retirement as early as possible! Ask your kids to invest their first paychecks from high school jobs. And most importantly, let the money compound uninterruptedly for as long as possible. And if you want to take full advantage of compounding, Turbo Charge Your Portfolio With Reinvested Dividends.

Relevant Articles:

- Determining Withdrawal Rates Using Historical Data

- Why do I like Dividend Aristocrats?

- The case for dividend investing in retirement

- When to sell your dividend stocks?


  1. You have hit the nail on the head start early!

    Being in my late 40’s I can not stress this enough to my co-workers hopefully they can learn from my mistakes.

    I tell them all about my web page with a data base of over 180 companies that offer direct purchase plans.

    I got on a site the other night and figured that if you had invested $50 a month in the following companies over a 10 year period you would have invested $6300 in each company and by rolling over dividends the numbers are listed below.

    (PFE) TOTAL WORTH $4975 (-21%)
    (XOM) TOTAL WORTH $128931 (+104%)
    (BAC) TOTAL WORTH $9082 (+44%)
    (PEP) TOTAL WORTH $9937 (+57%)
    (K) TOTAL WORTH $10726 (+73%)

    Your total investment over the 10 years would have been $31,500 and it would be worth $47,814
    Not a million dollars but a start.

    Here are the number of shares and yearly dividend payout you would be getting.

    (PFE) 256.06 Shares $327.76 in yearly dividends.
    (XOM) 164.6 Shares $102.88 in yearly dividends.
    (BAC) 271.52 Shares $695.09 in yearly dividends.
    (PEP) 144.98 Shares $246.47 in yearly dividends.
    (K) 199.46 Shares $271.27 in yearly dividends.

    If after 10 years you never invested any more and only rolled over your dividends that is $1643.47 you would be investing and it would keep growing as your shares built up.

    The reason I used these companies in the example is they are a few of the companies that offer company paid investment plans after you make the initial purchase.
    That means they pay your investment fees for you.

  2. Aplusssrc,

    Thanks for stopping by. This is indeed a very good example using real data that a basket of dividend paying stocks where you dollar cost average your purchases will amount to a sizeable sum over time.
    With the sample portfolio listed above, you'd be earning over 5% based off your $31,500 investment.
    I have a question to ask you - could you please e-mail me back at
    dividendgrowthinvestor at gmail dot com.


Questions or comments? You can reach out to me at my website address name at gmail dot com.

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