“It helps to communicate that the client already owes himself the money for the future, and that it’s actually quite a lot. By saving a little bit more today, he’s actually lowering — dramatically — the amount he owes himself for the future.” – Chip Castille

As Warren Buffett closed in on age 60 in 1989, his net worth was $3.8 billlion according to the Forbe’s List. This year, as Buffett approaches his mid-80s, he’s worth $58.5 billion. That means nearly 94% of Buffett’s current net worth was created after his 60^{th} birthday.

I’ll come back to these facts again after we go through a simple example.

Most retirement calculators offer you fairly simple inputs. You basically enter in the amount you currently have saved, your future saving projections and a return assumption. Then the calculator spits out a future value based on those assumed inputs.

This isn’t a perfect way to determine exactly how much money you will have saved up by retirement because it’s impossible to precisely map out the future when the markets and your life are in a constant state of flux. That’s why retirement planning is more about accuracy (in the ballpark) than precision (bulls-eye).

With that in mind, here here are some basic assumptions for a hypothetical young person with a long time horizon ahead of them that you might see in a typical retirement calculator:

You can see that a steady diet of a double digit savings rate coupled with decent investment returns and a healthy does of compound interest can turn our hypothetical saver into a millionaire by the time they retire.

Looking at these numbers would lead you to believe that your investment returns carry the bulk of the weight, considering almost 80% of your ending balance comes from compounded investment gains.

But breaking out these results by different periods tells us a much different story. Here’s how things look by age 35:

And again at age 40:

Ten and Fifteen years in and the amount you save is still the most important factor in this portfolio’s growth. In fact, it’s not until somewhere between the ages of 43 and 44 that our retirement saver sees investment gains overtake the amount they have saved over time.

So in this example it takes almost 20 years for investment returns to take over from the amount saved. And here’s a little secret about the compound interest in these retirement calculations — the majority of the growth comes once a large balance gets built up as you get closer to actual retirement age. Here’s the growth in the final decade before retirement using my assumptions:

Remember, in this example this person continues to save right up until retirement, but the performance doesn’t really start to build the balance until there the law of large numbers comes into play.

This is where the Buffett example from the above comes into play. Obviously, it’s a bit of an obnoxious comparison because Buffett is one of the richest people in the world. But this does show that saving money slowly can build upon itself until all of the sudden compound interest explodes.

This is where real wealth comes from. It takes time and it’s not easy. It could take decades to see extraordinary results, which is much longer than most people would like. As life expectancy continues to increase the virtue of patience and an understanding of your time horizon become more important than ever.

A few more lessons from this basic example:

- It’s more exciting to focus on milking a few extra basis points of investment returns out of the financial markets, but this shows that the amount you save in the first few decades of your career is much more important for all but the very best investors.
- Increasing the % of salary saved in this example from 12% to 15% has nearly the same effect on the ending balance as increasing investment performance by 1% a year. Up the amount saved to 20% of salary and it equates to an extra 2% a year in market returns. Based on decades of academic research, earning more in the markets is much more difficult than saving more money.
- Markets don’t give you the same returns year-in and year-out like you see in retirement calculators and this illustration. Nothing moves in a straight line. Average market performance is anything but average. Since you have no control over total market returns or the sequence of those returns (which also plays a huge role in your ending balance at retirement) you must focus your energy on that which is within your control.
- That means how much money you save is much more important than most investors assume. Your initial returns as you start out definitely help plant the seeds, but the greatest investment strategy in the world means nothing if you have no capital to invest in it.
- Deconstructing compound interest into different time frames shows the power of sticking with a long-term plan. It may seem like every tick in the market is going to make or break your portfolio, when in reality the fairly simple action of saving more money can have an enormous impact on the size of your portfolio.

Further Reading:

**The real world retirement calculator**

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