Editor’s note: This article was first published in March 2013; the deposit interest rates, cigarette prices and Apple share returns it cites are 2013 figures.
Have you thought about your retirement? At 30 maybe not yet, but the truth is that the right time to start a financial plan is at 25. In fact, the sooner you start, the easier it will be to retire in a comfortable financial position. I don’t mean to spoil your day, but most elderly people agree that they, too, saw retirement as something very far off, and in the end it arrived almost without them noticing. Some live more comfortably and others are more stretched financially. Most of them regret not having had the financial knowledge they needed and fall back on the usual “if only I had known”… so we are going to tell you now.
The goal: 1 million euros by age 70, taking into account all the factors we are going to look at below. Saving 1 million euros may be something very few people have ever considered, but in reality, achieving it by 70 is relatively easy. In our article “The financial prison” we put together a table of how much you need to save every month to have that million euros. If we start with initial capital of 10,000 euros, we would need a return of 10% a year, reinvesting the interest, to reach 1 million euros in 45 years, at age 70. We know that 10% a year is far from easy, so we will save certain amounts every month to make sure our goal is within easy reach.
- If we start at 25, to have 1 million euros at 70 we only need to save 450 euros a month, about 15 euros a day.
- At 35, we would need to save 850 euros a month.
- At 45, the amount we would need to save would be 1,700 euros a month.
- At 55, we would need to save roughly 4,000 euros a month.
The truth is that 450 euros is not crazy at all. During the good times we have spent more than that on things we didn’t need. Let’s always avoid the six most common bad financial habits.
The real value of money
A euro today is worth 1 euro today, but tomorrow the value of that saved euro may be 100 euros or 0.50 euros. The value our euro ends up having will depend on how we manage it.
A basic principle of financial education: roughly every 20 years, our money is worth half as much. In other words, inflation erodes our savings by about 50% every 20 years. That is why many savers only save and do not invest in anything at all, because they don’t want to take risks, when in reality not putting your money to work means running the risk of losing 50% of your savings. Here are a few maths tricks from financial education that you can work out very easily.
When drawing up a plan for our retirement, we must bear in mind that the secret, or trick, is for the returns from our investments to be higher than the inflation rate.
What kind of investments can we choose for that? Depending on our risk profile and starting knowledge, we will have different options. (Read: Which investments are most profitable for reaching financial freedom.) In that article we set out the different returns we could expect from each type of investment, with the most profitable, logically, being the stock market and your own business. In fact, if we follow an investment strategy based on companies with good dividends, we could find returns of more than 10% a year, always adding the gains back into our investment capital. What is clear is that money has to be put to work, no matter what; otherwise, you are losing money.
…Or we can set a different horizon
We have talked about retirement, and as we have seen, reaching that million euros by 70 may be fairly simple; off the top of our heads, we would then only need to put it into 3% deposits to generate 30,000 euros a year in interest.
See also: Preferred shares: there is hope of getting the money back
That said, many people are not attracted by the idea of living well at 70 without being able to enjoy themselves earlier, so it is a matter of setting goals. Do the maths to work out how much you would need to save, or what return you would need, to have that million euros at 40. What is clear is that you would have to take on much more risk, because you would be forced to get high returns. As a general rule, the only way ordinary people can retire early and young is through their own business or by holding a senior position in a company.
The other day I saw a lawyer who, when she was young, told herself that she wanted to retire at 40. And that is what she did. She admits that she knew how to save and grow her savings, and as soon as she turned 40 she retired to enjoy her money and travel the world.
Mind you, whatever goal you set yourself, you should enjoy the whole process and be doing something you like. Otherwise, that million euros would not be worth it.
What is very clear is that most millionaire households, with the odd exception, have in common that for some years they lived an extremely austere life, and later on they did not spend money on luxuries such as high-end cars, expensive watches, 2,500-euro suits or 2,000-euro-a-night hotel stays.
And most important of all… debt
If you take on too much debt when you are young, you are wiping out your chances of saving. (Read: How to pay off $90,000 of debt in three years.) Of course, there is good debt and bad debt. In our article “Five signs that you are living beyond your means“, we described bad, toxic debt as using credit to pay for a product whose useful life is shorter than the term of the loan repayments.
Obviously, if we want to start a business, we will need to take on debt, but that debt is good as long as the business is profitable, of course.
We must be very careful with debt. Being able to buy something on credit does not mean you can afford it, even if you can make the payments. And before buying something outright, think about whether it is something you really need.
When drawing up a strategy for a financial plan, we shouldn’t just look at the fact that something costs only 200 euros today, but at the fact that those 200 euros we are about to spend could be 15,000 euros in 20 years if we invest them and add the returns (compound interest). In other words, what we spend on a pack of cigarettes today (4.80 euros) may really be costing us more than 400 euros. If you think this way, you may even lose the urge to smoke.
Imagine that in 2003 you faced this question: should I buy 100 euros of Apple shares or spend it on dinner out? If you decided to spend it on that dinner, the dinner cost you 6,117 euros, because that is how much Apple has gained in value over these 10 years. It is a somewhat extreme example, but a completely real one.
And finally…
The last question is whether to take on more or less risk to achieve your goals. We all know that the more risk we take on in an investment, the greater the return or the losses will be. Each person should take the risks they are prepared for and understand. Sometimes what is “high risk” for one person is merely an acceptable risk for another. Some people regret not having taken more risks, and others regret having taken so much, which is why, on this subject, each of us has to decide how much risk we are willing to take, since it will depend on the goal we have set, our means and our knowledge.
Further reading
- Five tips to improve your personal finances
- What does being rich really mean? A former Goldman banker explains
Featured image: Flip Schulke, Public domain, via Wikimedia Commons.
