The Importance of Saving (Part II)
Click here for Part 1 of this piece.
NEW YORK ( TheStreet -- Continuing from Part I of my article on saving for retirement, now our individual has opened a Roth IRA account with $5,500 to get the ball rolling and just took the first step to securing her financial freedom. It should also be noted that the account can be opened with any amount between $0 and $5,500.
To contribute the maximum amount per year to the Roth IRA, our individual will need to save about 15.3% of her take-home pay through her 30s. While this might not seem like a "fun" way to "spend" your money, it will prove rewarding down the stretch. By the time our individual reaches 40, she'll already have $60,500 in contributions alone.
Just for fun, we can assume she allocated 70% of her portfolio to stocks and 30% to fixed-income. On average, we'll say the stocks returned 8% per year and the bonds returned 3%. While contributions have totaled more than $60,000, returns from our investment strategy have brought the total up to $90,246. Not too shabby.While our investor continues to save 15% of her $43,200 take-home pay through her 40s, she now has over $115,500 in contributions alone. With the increase in age, our investor has shifted herasset allocation to 65% stocks and 35% bonds in an attempt to decrease risk. After contributions and returns, the total savings is now up to $255,811. Now that our investor is in her 50s, things change slightly -- most notably, the annual contribution limit. When you hit 50, you can contribute $6,500 instead of the standard $5,500. This is known as a catch-up contribution. With our investor still saving 15% of their pay, she will contribute another $65,000 to her Roth IRA over the next decade, bringing the total amount of contributions to a robust $180,500. Let's again assume in our example the investor shifts slightly away from stocks in favor of bonds. The asset allocation is now 60% stocks and 40% bonds. Assuming the 8% return rates from equities and 3% return from bonds, the total stock fund is worth just over half a million dollars, while his bond fund is now worth just north of $100,000.
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