The Fruits of Your Assets

A few posts ago, I discussed the establishment of a savings target. So how do you turn that target into a savings goal for the year? I’m glad you asked.

Remember the example of Ernie? He had established a target. He wants to have $948,750 saved by his retirement. Let’s add two facts: Ernie is 25 years away from retirement, and has already accumulated $75,000 in a 401(k) account. Good for him! Because that $75,000 will do part of the work for him, reducing the burden on Present Ernie and Future Ernie. Thank you, Past Ernie.

Ernie wants to do a projection of how much of his $948,750 target he can expect his $75,000 to cover. First he needs an assumption about what rate of return he might expect. There’s no way to know that, but it’s not so important that his assumption be right. It won’t be. Not even Ernie can predict the future. Rather, it’s only important that it be reasonable. He can (and should and, by golly, will) make mid-course corrections every year to make up for his inevitable failure to predict the future. So what’s a reasonable assumption? For illustration purposes I will use 6%. In a future post I will describe the myriad factors that go into that assumption, but for now, grant me that it’s reasonable.

Ernie projects that, in 25 years, with an investment return of 6%, his $75,000 will be worth $321,890. How did he do that? There are lots of ways to do that sort of financial projection.
• You can use a financial calculator.
• You can use this formula, where “A” is your current assets ($75,000); “r” is the assumed rate of return (6%); “N” is the number of years to go (25); and “F” is the future value of your assets:

F = A * (1 + r)^N

• You can use an Excel spreadsheet.

Lots of ways to get there. The important thing is that Ernie’s prior savings are going to do 34% of the work for him, leaving him with a net target of only $626,860 to save for out of his current and future salary. So how much should he save? That’s for another post, because I gotta go.