Wealth is accumulated regular savings plus returns on these savings if invested well. Regular Savings in turn comes from excess of your monthly income over expenses. Income could be your salary or profit from your business.
When you start your career / business, in the initial few years, each year, the annual saving is the bigger component of the wealth added in that year. This is because cumulative savings is small for the returns on that to be significant enough.
However, after 10-15 years have passed, the accumulated investments become large enough for the annual returns on them to exceed your savings for that year. So you hit the sweet spot then – your efforts of past years start giving you more bang for the buck than that of the current year. This continues till you retire and my calculations show that typically, about 30-35% of your wealth growth in later years will come from savings and rest from returns on investment.
So, coming to the question of setting your targets – I would like each one of us to hit the 50:50 sweet spot (between savings and returns on investment) by the 10th year of your career. That gives you enough time after that to build a good retirement “nest-egg”. Incidentally, if you hit the sweet spot later than 15 years after starting your career, there is a big chance that you will run out of your savings by the time you are 75 !! This will happen because after retirement your income will become zero and your monthly expenses will come from your accumulated wealth, which will get reduced by net amount of expenses less returns on remaining investments.
Running out of your wealth at 75 could be a scary prospect – this could be prolonged by doing one or many of the following :
- Increase rate of savings in initial years – doubling it in first 10 years of career will increase 75 years to 79 !
- Increase rate of savings in later years – say, increasing from 30% to 40% in last 10 years of career will increase 75 years to 82 !
- Increase returns on investments by being very savvy / risk-taking – increasing such RoI by 3-5% p.a. in first 10-15 years will increase 75 to 78 !
Serious stuff, no doubt ! To be taken seriously…if you cannot handle all these numbers yourself, get a financial planner / wealth advisor to do this. Better to be informed than sorry…