Just contributing to your retirement savings is not enough. You’ve got to make them earn decent returns so their compounding effects significantly add to what you eventually accumulate. To settle for pathetic investment earnings makes saving for retirement only a contribution game with meager results. This article shows the kind of earnings you need to compound your way to a decent retirement.

Government-regulated retirement programs, like your 401(k), 403(b) or IRA are geared to help you save for retirement. Though their annual contributions are limited, they’re deductible from you working income. This helps you contribute more to your savings than using after-tax dollars. Their tax-deferred growth allows all your earnings to contribute to the compound rate of your savings without any loss annually to income taxes.

I’ve constructed an example to show how important it is to get decent earnings on your investments to accumulate significantly more and to make your earlier contributions pay off.

Let’s consider that you have 40 years over which you can contribute and grow your money. But there are two different contribution options by which you can choose to contribute. The first option is that you contribute just $1,000 (i.e. $1K) to your savings every year for the first 10 years. But then you don’t contribute any more for the remaining 40 years; you just let your 10 years of contributions grow by its investment earnings. Your total contribution under this scenario is $10K. Let’s call this option the ‘$10K early’.

The second option is that you forego any contribution for the first 10 years, but then contribute $1K per year every year for the last 30 years. Of course these contributions will grow also by their investment earnings, too. Your total contribution in this second option is $30K – three times as much as in the first option. Let’s call this option the ‘$30K late’.

Now, let’s compare the resulting accumulations after 40 years for both these options for different compounding rates. The compound rate is that amount of investment earnings annually left in your savings to grow- not lost to taxes or fees. A 4% earnings rate that lost 25% of the earnings to taxes would compound at 3%. A 4% tax-deferred earnings rate has a 4% compound rate.

4% compound rate accumulations:

After 40 years at a 4% compound rate, the ‘$10K early’ accumulates to $40K (4 times what was contributed), while the ‘$30K late’ accumulates to $58K (about 2 times what was contributed). So you ended up more with the late contribution option – but of course you contributed 3 times as much.

6.3% compound rate accumulations:

After 40 years at a 6.3% compound rate, both contribution options accumulate to $88K. This compound rate was chosen to produce this result. Clearly, as earning rate increases so do your accumulations. But now those early contributions earn far more: 9 times more than the $10K early contribution, and only 3 times more than the $30K late contribution.

8% compound rate accumulations:

After 40 years at an 8% compound rate, the $10K early contributions accumulated to $157K while the $30K late option accumulated only to $122K. Again, increased earnings accumulate more. But now your investment earnings are contributing a greater share to your accumulations.

The magic of compounding is making those early contributions win out over larger later contributions. Comparing final accumulations, the $10K early option achieved almost 16 times contributions versus a little more than 4 times contributions for the $30K late option.

Higher earnings not only produce higher accumulation amounts but a huge difference for when the contributions are made.

Learn to make your savings work hard:

Recognize first that getting higher earnings rates significantly enhances your final accumulation no matter when you contribute over a long time. But, second, they make those early contributions work hard at earning much more than later contributions.

Many people waste their savings in low earning savings vehicles. They play it too safe or pay too many fees – or both. Though they worked hard to contribute to their savings, they dropped the ball on making those contributions do their share of earning.

You should be able to get your investment earnings over 6% at least – and ideally up to 8% – and more. These growth earnings are below the average for stocks over 80 years (1926-2006) as shown by Ibbotson Associates.

So I emphasize that there are 2 parts to achieving independence:

o Contributions

o Investment earnings

– one is not enough

Contribute to your savings – starting as early as possible – so you can also get the benefit brought by decent earnings. Then work at getting earnings of 8% or more. Make your savings work as hard as you do.