A Little Bit Over Time Adds Up

Dave and Sue engaged in some financial housekeeping as they anticipated the birth of their first child. To their surprise, the person who helped them the most was Roy, the man who had cut Dave’s hair since childhood. One of the financial nuggets Roy offered the guys waiting for a haircut was to save 10 percent of their income for retirement. “Thirty-five years ago,” Roy told them, “I started my savings with $30 a month. As my income rose, my 10 percent savings component rose accordingly. Thirty dollars a month became $60, then $100, and eventually hundreds of dollars a month…. You are looking at a very wealthy man.”

Author David Chilton uses this story to develop the premise that saving a little over time can provide a lot of money for retirement (The Wealthy Barber: Everyone’s Commonsense Guide to Becoming Financially Independent). Is this true in non-fiction, too? Can a person create a firm financial foundation over a lifetime by saving 10 percent each month?

Rules of Thumb and Financial Calculators

A financial rule of thumb provides quick and easy guidance. For example, some financial advisors counsel people to have 10 times their annual income in life insurance. A person can simply do the math and buy a policy. Unfortunately, this rule of thumb oversimplifies the situation. Insurance is a form of risk management. My son provides the primary income for his wife and three children, and as a young man his family faces more financial risk should he die than my wife would if I died. The rule of thumb about life insurance coverage would be more appropriately applied to him than to me. So in making financial decisions, you sometimes need to look deeper than a basic formula.

Financial calculators can be helpful in scrutinizing a financial issue. Generally speaking, the more data entered into a financial calculator, the more accurate the results. With life insurance, for example, a helpful financial calculator will ask about details such as burial expenses, income replacement for the lost wage earner, resources for children such as college expenses, and a mortgage to be paid in full.

So is the rule of thumb about saving 10 percent valid? In true MythBusters fashion, I determined to discover the truth.

Real Data in Real Time

To answer the question, I used my own financial history. I started in 1978, the first full year of employment after I graduated from college. I served as an associate pastor that year. I used the data provided by the Social Security Administration for my annual income through 2013. My income from pastoral ministry has been modest; the median is $25,181. My calculations assumed I had made contributions to a retirement account each month for the 36 years that equaled 10 percent of my income. I used the historic annual returns of the S&P 500, Standard and Poor’s index of 500 leading companies in the United States. The range of return swings from an exhilarating 31.74 percent in 1980, to a crushing -36.55 percent in 2008. The average return for these 36 years is 13 percent.

The calculations revealed a slow start at building the account; it took 16 years to cross the $100,000 mark. But then the phenomenon of compounding kicked in as earnings on earnings exponentially increased the balance. The figure at the bottom of the page astounded me, so I checked and double-checked my calculations. If I had deposited 10 percent of my income each month for 36 years in an account that followed the S&P 500, I would have had $1,032,822 at the beginning of 2014.

In my pastoral ministry, I served small- to intermediate-sized congregations. I’m guessing my compensation from pastoral ministry was always below the national average of all wage earners. In the early years, we qualified for federal assistance through programs such as WIC, the food and nutrition subsidies for women, infants, and children. And yet, consistently saving just 10 percent would have been enough.

If only.

The truth is: I did not begin in my mid-20s, but waited until I was almost 40 years old to start saving for retirement. Once I got going, I diligently gave attention to future needs. My wife and I voluntarily reduced consumption in the moment so we would have adequate resources in retirement. And I think we’ll be okay. But it would have been a lot easier if we had started earlier. Starting when I did, I would have had to save one-third of my income to end up with the same amount I could have had if I simply put away 10 percent from the beginning.

In the end, it looks like Roy the barber was correct. This rule of thumb is confirmed.

Bankrate.com has a multitude of calculators for personal finance issues such as budgeting, debt reduction, insurance planning, and retirement readiness. Some of the calculators are quite interesting. A pastor might use the comparison between the cost of living in two cities when anticipating a move. Another calculator shows the net gain of a spouse’s employment when considering the additional expense of childcare, transportation, etc. The cost of raising a child is quite revealing. Another calculator seeks to answer the question: “Does it really save money to drive halfway across town for cheaper gas?”

Originally published by Pensions & Benefits USA.