Do You Even Need Investment Returns to Retire Early?

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8 min read

Albert Einstein supposedly once said, “Compound interest is the eighth wonder of the world.” But does data actually support this famous statement?

In this post, I explore the nature of compound interest, how long it takes to become an important factor in wealth accumulation, and whether or not it actually matters much for people who hope to achieve financial independence in a relatively short period of time.

Accumulating Wealth in the Early Years

Suppose your goal is to achieve a net worth of $1 million. If you invest $10,000 every year and earn a 7% annual return on your investments, you’ll accumulate $1 million in about 30.7 years.

The chart below shows exactly how long it would take to reach every $100k net worth milestone, using the assumptions of a $10k annual investment earning a 7% annual return:

Notice how each $100k net worth milestone takes less time to reach than the last. In fact, it’s mind-boggling to see that it will take you longer to go from $0 to $100,000 than it will to go from $600,000 to $1 million:

The reason the first $100k takes the longest to save is because you don’t receive much help from investment returns early on. The time it takes you to go from $0 to $100k is mostly dependent on the gap between your income and your spending.

The following chart shows just how much savings contribute to net worth growth compared to investment returns:

If you invest $10,000 each year at a 7% annual rate of return, you’ll go from $0 to $100k in 7.84 years and a whopping 78% of that $100k will come purely from savings.

Even if you earn higher annual investment returns, the majority of your first $100k will still come from savings. The table below shows how much savings account for each $100k net worth milestone based on different annual rates of return:

On the low end, if you only earn 3% annual returns, then savings will account for 89% of your total net worth growth from $0 to $100k. On the high end, if you earn 9% annual returns, then savings will still only account for 74% of total net worth growth.

The good news is that once you cross the $100k net worth milestone, investment returns begin to help you out. For example, if you keep investing $10,000 each year at a 7% annual rate of return, then 49% of your net worth growth from $100k to $200k will come from investment returns:

So, even though you’re saving and investing the same amount each year ($10,000), it will only take you 5.1 years to go from $100k to $200k since investment returns add to your net worth. Notice how it takes less and less time to accumulate each $100k because investment returns begin to account for more growth as time goes on.

Why Saving Your First $100k is a Big Deal

You might find these charts discouraging if you’re someone who has yet to save their first $100k. After all, the numbers don’t lie: the first $100k takes the longest to accumulate. Warren Buffett’s longtime business partner Charlie Munger even once said, “the first $100k is a b*tch.”

The good news, though, is that accumulating your first $100k represents a huge milestone. If your goal is to save $1 million, then $100k only represents 10% of your total goal. But let’s instead view wealth accumulation from a time perspective: It takes 7.84 years to get your hands on that first $100k and a total of 30.7 years to go from $0 to $1 million.

This means accumulating the first $100k takes up a whopping 26% (7.84 years / 30.7 years) of the total time it takes to accumulate $1 million:

Although it may not feel like a huge milestone in terms of dollars, accumulating your first $100k is a huge milestone in terms of time.

It’s fascinating to see how much time each $100k milestone actually accounts for on the road to $1 million. For example, going from $100k to $200k represents 17% of the total journey in terms of years:

This means that accumulating your first $200k represents 43% of the journey to $1 million in terms of years. The table below shows how much time each $100k takes up on the journey to $1 million (again, assuming consistently investing $10k annually at a 7% rate of return):

As your net worth marches higher, each subsequent $100k takes less time to reach than the last.

When Do Investment Returns Matter More Than Savings?

We’ve seen that net worth growth can be slow in the early stages simply because you don’t have enough money invested for investment returns to make much of a difference. As time goes on, though, investment returns begin to account for more and more net worth growth. This begs the question, when do investment returns matter more than savings

To answer this, let’s consider the case from earlier where you invest $10,000 and earn a 7% annual return. At the end of year one, you have your initial $10,000 plus $700 in investment returns for a total of $10,700. This means 93% ($10,000 / $10,700) of your net worth growth came from savings and only 7% ($700 / $10,700) came from investment returns.

In year two, you invest another $10,000 and again earn a 7% return. This year you would earn $1,449 (($10,700 + $10,000) * 7%) from investment returns. This means 87% ($10,000 / $11,449) of your net worth growth came from savings and 13% ($1,449 / $11,449) came from investment returns:

If we keep doing these calculations each year, we’ll find that investment returns account for more and more of yearly net worth increases as time goes on:

Notice how it takes about 11 years for investment returns to account for more yearly net worth growth than savings:

After year 11, investment returns become the main force that pull your net worth higher.

Here’s another way to view these numbers:

It turns out that no matter how much you save each year, these numbers hold true. For example, suppose you saved $20,000 consistently each year instead of $10,000:

Only the net worth numbers change. The percentages stay the same. Investment returns overtake savings again in year 11.

But what if you earn less than 7% annual returns on your investments? For example, suppose you save $10k each year again but instead earn 5% annual returns:

We see a similar pattern: Investment returns slowly begin to account for more net worth growth over time, but in this scenario it takes about 15 years for returns to become more important than savings.

This brings up an interesting question: How long does it take for investment returns to overtake savings for different annual return amounts?

This table reveals the answer:

The lower your annual investment returns, the longer it takes for investment returns to become more important to net worth growth than savings. 

How Much Do Investment Returns Matter for Early Retirees?

We’ve seen that the amount you save often matters more than the investment returns you earn in the early years of a net worth journey. This brings up an interesting question: how much do investment returns matter for people who hope to achieve financial independence in a time span of only 10 to 20 years?

According to the Financial Independence Grid, a household that is able to save 50% of their post-tax annual income each year will be able to achieve financial independence (25 times their annual expenses) in just 16.6 years, assuming they start with $0 and earn 5% investment returns each year:

Let’s round this number up to 17 years and find out just how important investment returns vs. savings are on the road to financial independence. Using the Contributions vs. Returns Calculator, we can find out just how much investment returns matter.

Note: I’m using the term “contributions” and “savings” interchangeably here.

Consider a household that is able to invest $30,000 per year at a 5% annual rate of return for 17 years. At the end of these 17 years, they’ll have $813,972, 63% of which will have come purely from savings. Only 37% of this total ending amount will have come from investment returns.

Consider instead if this household is able to earn 7% annual returns. It turns out that they would be able to achieve F.I. in just 15 years. In this case, investment returns would account for 44% of their total net worth after 15 years:

And if this same household instead earned stellar 10% annual returns, they would be able to achieve F.I. in just 13 years. In this case, investment returns would account for 52% of their total net worth after 13 years:

So, for people who are able to achieve F.I. in 13 to 17 years, investment returns account for anywhere from one-third to one-half of total net worth growth.

Conclusion

We saw a few interesting things in this post:

  • On a net worth journey, the first $100k often takes the longest to accumulate. Each subsequent $100k takes less and less time to accumulate, though.
  • The amount you save matters more than your investment returns in the early years.
  • For people who are able to achieve F.I. in 13 to 17 years, investment returns account for anywhere from one-third to one-half of total net worth growth.

Your job as an individual is to focus on what you can control. This means focusing on increasing your income, keeping your spending in check, minimizing investment fees, and maintaining an asset allocation that aligns with your financial goals.

If you hope to achieve financial independence in a relatively short period of time, you’ll likely be better off focusing on these variables you can control rather than fretting over investment returns, which are largely out of your control. 


My favorite free financial tool I’ve been using since 2015 to manage my net worth is Personal Capital. Each month I use their free Investment Checkup tool and Retirement Planner to track my investments and ensure that I’m on the fast track to financial freedom.


Full Disclosure: Nothing on this site should ever be considered to be advice, research or an invitation to buy or sell any securities, please see my Terms & Conditions page for a full disclaimer.

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