So you want to be a millionaire
Compound interest and the psychology behind automatic deductions work for you, writes Susan Edmunds.
Fancy being a millionaire in retirement? There’s good news and bad news. First the good. If you are 20, saving $300 a week in an account with 5 per cent returns a year would give you $1 million by the time you are 65.
And of that, more than $580,000 will be compound interest – returns upon returns, not money you have put into the account yourself. Now the bad.
If you’re a bit older, it’s a lot more difficult. A 30-year-old would need to save $420 a week.
A 40-year-old would need to put aside $645 a week to reach that savings goal and only $338,2250 of the final total would come from compound interest.
How to do it
If you’ve decided to make it your mission to save money, there are some ways to make it a bit easier on yourself.
David Boyle, of Mint Asset Management, said starting early would be important.
Paying yourself first is a good idea. KiwiSaver balances are now a median $13,000, up 62 per cent on three years earlier. The scheme’s success lies in the money being taken from your pay before it lands
in your bank account, and then you can’t touch it. If you’re trying to save anywhere else, applying those same principles will help.
Boyle said people should aim to increase what they saved over their working lives.
Set aside a portion of your income when you start in a job, then leave it set at that proportion so that what is put aside increases over time as your income does – and it’s saved before you get used to having the extra money available to spend.
But do you even need a million?
Apart from the fact that it’s a nice round number to strive for, is there a good reason to aim for $1 million in savings?
Some commentators have even suggested $2m might be required.
There is a rule of thumb that dictates you can afford to withdraw about 4 per cent a year from a saved nest egg each year without significantly eroding the overall balance.
That would mean a $1m balance would generate $40,000 in income a year.
If you were willing to draw down some of your original capital, too, you could have more in the hand each year – which should be sufficient to cover most outgoings in retirement, especially if you already had paid off a house.
But adviser Liz Koh warned it was a high target to aim for.
‘‘Given high property prices and therefore high mortgages, it becomes quite a stretch to save $1m. I would say that if a couple have a debt-free home and, say, $500,000 in retirement capital, they should be able to live comfortably in retirement, but there are many factors that come into play. In Auckland, this may not be enough. In rural areas, they may well need less.
‘‘Overseas travel is a big factor too – so people with children living in Europe who want to visit them regularly may need even more.’’
Boyle agreed what people needed would depend a lot on their own circumstances, what they liked to do and where they wanted to live.
Boyle said there was a risk that when people heard that they should save $1m or $2m for retirement they would just switch off because it seemed impossible.
Tom Hartmann, managing editor at the Commission for Financial Capability, agreed. ‘‘Most people would need less than that to fund their lifestyles.’’
‘‘Overseas travel is a big factor too – so people with children living in Europe who want to visit them regularly may need even more.’’ Financial adviser Liz Koh