This is my favorite step! Once you have learned to budget and live within your means, paid off your debt and saved up 3 to 6 months of expenses, you finally get to start putting money towards growing your future dreams instead of just escaping your financial nightmares. This step is SO important because you have relieved all the pressure from the present financial struggles so that are free to project yourself into the future and decide who you want to be in 10, 20, 30, even 40 years from now. Before I jump into the how, I want you to consider a few questions. Think about what you want your dream retirement to look like. Jot it down. Do you want to travel more? Do you want to volunteer more? Do you want to spend more time with family? This is what’s going to motivate you to complete step 4, contribute 15% of your income towards retirement.
In Chris Hogan's book Everyday Millionaires, they did a study of over 10,000 millionaires and the number 1 vehicle they used to create wealth was their 401k. A 401k is an investment account that you contribute to at each paycheck that gets invested into mutual funds or index funds like the S&P 500 for example. Your employer may offer a match for whatever you contribute or it may be only what you allocate from your check pre taxes.
Let’s use the S&P 500 as an example. Since the inception of the S&P 500 in 1926, the average annual returns of this Index Fund has been 10% annually. That means if you invest $100, in 1 year you will have $110. Then both the principal and annual interest get to experience what is called “the compound effect.”
Let’s take a look at the example below to demonstrate how the compound effect works.
Meet Joe, at 21 he started to contribute $2400 a year for 10 years to his 401k that he invested in the S&P 500 and then he didn’t contribute for the rest of his life but allowed the balance and the yearly accruing interest to grow at 10% until he was 67. At 67, he has invested $24,000 of his own money but the balance has now grown to $1,477,156.
Meet Steve, at 31 he started to contribute $2400 a year until he turned 67, also receiving 10% interest. At 67, he has invested $86,400 of his own money but the balance has now grown to $841,351.
This is the compound effect! Steven never caught up although he contributed over 3.5 times the amount than Joe. This message is to motivate you to start now! The longer your money hangs out with compounding interest and time, the better your retirement will look.
Also, if you are self employed, you can open a Roth IRA and contribute to it. It works a little differently than a 401k in how it is taxed but it is also a retirement account that can be invested and receive the magic of compounding interest.
Remember, you are first to start a budget, save $1000, attack your debt with a vengeance until it’s paid off, save 3 to 6 months of expenses for emergencies, and only then start contributing 15% of your income to retirement.