Want to Reach Your Retirement Savings "Threshold"? Be Sure to Heed the Signs Along the Way!

In an earlier piece, with a reference to Albert Einstein, I wrote about “compounding” the compound interest on your retirement savings by making regular contributions. That’s a key first step to ensure a steadily growing savings balance, particularly if there’s an employer match to go along with your contributions. But for that savings growth to take a sharp turn upward there’s also an important second step: WAITING.

Why? Because if you hang in there long enough you’ll finally be rewarded by reaching a critical threshold…a point when the compounding effect really kicks in and your savings starts to grow at the speed of light (well not quite that fast, but you get the idea).

The story of the king and the court jester illustrates this compound interest threshold. Legend has it that a long, long time ago a court jester’s heroic act saved his king. The king was so moved by the jester’s bravery that he offered to give the jester anything he wished for. The jester wished for one cent, doubled each day for a month. “That’s all?” said the king. The wish was granted.

Halfway through the month the balance grew to only $164. But during the final week it started its rapid rise — it passed the threshold — and spiked, ending the month at over $5.3 million.

While it took some time for the small initial amount to grow, eventually the balance grew large enough so that with each doubling it started shooting up very rapidly.

So how can you reach your retirement savings threshold? You just have to heed some signs along the way.

"START" Early

First, Start early. As the graph above shows, you need to invest as much time as money for the compound interest formula to work.

"GO" For Maximum Contributions

Next, Go for the maximum contributions you can afford. If your employer offers a 401(k) or similar type of matching account, be sure to contribute at least an amount that maximizes the company’s match. For example, if they match your first 3% dollar-for-dollar, then your 3% contribution doubles to 6%. There’s nothing better than free money, so at the very minimum contribute that amount — more, if the extra amount is tax deferred and you can afford to do so.

"PLEASE DON'T TOUCH" the Nest Egg

Remember: You need to wait. Avoid interruptions or reductions in your contribution amounts; whenever possible, increase them. And don’t touch your steadily growing nest egg, for doing so disrupts the compounding formula and can set you back many years. In particular…

Do Not "YIELD" to the Temptation to Withdraw

Make every effort to avoid withdrawing money from your retirement account. Most accounts impose hefty penalties for early withdrawals; plus you lose so much of that up-front compounding time you’ve invested. At times we all face financial challenges, but even on those occasions if at all possible make retirement account withdrawal the option of last resort.

An alternative to withdrawing money is to borrow from the account. As a general rule this too should be avoided but there may be exceptions, as long as you’re in a a position to repay the loan promptly. The advice of a financial advisor could serve you well when considering this option.

"WAIT" Before Collecting Social Security

Congratulations! If you started early, followed the signs and stayed with it into your 60s, you will have passed the threshold and accumulated a sizable nest egg. You can now supplement that amount with a Social Security payment. To maximize your Social Security benefit, follow the last sign: Wait.

You can begin collecting Social Security at any age between 62 and 70, but many people can’t wait so they start at 62. That can be a costly mistake, for benefits at that age are cut drastically. If on the other hand you delay Social Security from 62 to 70 your benefit increases by over 70%* if that’s too long to wait, then at least consider waiting a little longer than full retirement age of 66, because each one-year delay between 66 and 70 increases your payment by 8%.

So follow the advice of Albert Einstein…and the court jester. Also, follow the signs: Start early, maximize your contributions, don’t touch. And wait. If you do, you’ll be rewarded by crossing your retirement savings threshold.