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April 19, 2006


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To me the "magic" point is when you're consistently making more in interest or other earnings each year than you're making in contributions. That's when you really go "whoa, money for nothing!" At 8% APY that happens around the end of your ninth year, assuming you keep the contribution constant. That's why a guy who saves $500 a month starting at age 20 and STOPS at age 30 will end up with more than a guy who starts saving the same amount at 30 and continues for the rest of his life. By the time the 20-year-old hits 30, his savings is making his $500 monthly investment for him.

There are lots of important milestones for me in saving for retirement. However, unlike a lot of people I base them on exactly this sort of question rather than when I have saved round numbers. For example, I recently hit an important milestone: my retirement savings will compound on its own to an amount that will be sufficient to sustain my income at an the inflation-adjusted equivalent of what it is today, without any further contributions from me. That means that everything I save from now on toward retirement serves one of two purposes. The first is that it will increase my income after retirement. Since I still expect my pre-retirement income to increase, some of that will be necessary to maintain my lifestyle at the level I'll be enjoying just before I retire. Second, I can bring my retirement date closer.

That second point is the whole reason for paying attention to this particular milestone. I've based my retirement date on when I can start drawing from retirement accounts at 59 1/2 years old. If I want to have money to live off of if I retire at 57, I'd better have it in other accounts that I can tap earlier. Yes, I've reached the point where I need to carefully consider how much I'm putting into retirement accounts vs. non-retirement accounts.

The magic number is pretty simple. Take your savings and multiply by .04 (4%), if you can live on that amount of money, go ahead and retire. Theoretically you should never run out of money. Of course expenses can rise dramatically (think taxes, health care and energy) which may make this theory obsolete.

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