One million dollars in your superannuation fund. The task seems daunting, but the dirty little secret is it’s an achievable goal. You don’t need a massive salary or savings rate to get there. You need the magic of compound interest.

Financial literacy in Australia is poor, particularly for women and young people. This translates into a lower quality of life in retirement. Today I’m going to show you what it takes to reach $1 million in retirement. If you take one thing away from this exercise it should be that saving early in life, and taking advantage of compounding returns, is incredibly impactful later in life. The longer you put off saving, the harder is it to make the time back. Money makes money and that money makes more money.

If you’re a little bit older, or have some gaps in your savings, don’t be disheartened. Saving and investing early is the easiest way to reach $1 million, but it’s not the only way. Those in their 30s and 40s can still get there, but it takes a lot more sacrifice. What’s important is that everyone understands how to make their money work for them and how they’re tracking against their goal. Hopefully, this also convinces some to keep their money in super, not to take it out early, even when the Government says you can and by not taking on excessive risk.

Retire a Millionaire

Let’s say I make a pre-tax salary of $60,000 at age 25. I want to retire by age 67 with $1 million, which leaves me 42 years to reach my goal. How can I get there?
First, 10% of my salary goes into a superannuation fund every year to retirement—the mandatory minimum for employed Australians. Any returns I make are automatically reinvested. I also commit to making voluntary contributions of 2.5%. This can be a hard pill to swallow, especially for young people pushing all their after-tax savings into a mortgage (which will form an essential pillar of retirement). But the tax shield superannuation offers (15%) makes it worth it.

Now I need to make some assumptions:

• I assume the fund returns 7% annually (from the second year). Morningstar Research data shows top performing balanced super funds have returned closer to 9% (annualised, since inception), but we’re going to play it safe. These returns drop to 5% from age 55 to account for a reduction in risk.
• I also assume my salary increases 2.5% annually to retirement.

It’s said the first million is the hardest. It will take 25 years of diligent saving and investing to reach $500,000 but only another nine years to reach $1,000,000. That’s because my retirement savings generate their own earnings, which are reinvested. I will receive interest on the amount I invest from my salary each year, but also on the savings I’ve built up. By age 66, I have retirement savings of $1,644,221 – which includes total savings (after tax) of $464,353 and a total return on investment of $1,179,867.

As expected, return on investment starts slow, but comes home strong:

If we break down the yearly flows, you can see it’s really the compound interest effect (money made on money) that is really doing the heavy lifting and having the biggest effect.

Takeouts

Kids are costly. What struck me doing these calculations is just how important it is to save early in my career. Taking 5-years off in my early 30s to have children reduces your final superannuation balance by $414,424. However, if I’d taken 5 years off work at age 50, the change to my final balance was negligible, only falling by $155,905. If you’re going to take time off, consider how you could maybe contribute more before you take the time and how you could contribute more once you return to the workforce.

Don’t forget about inflation. Money today isn’t worth the same as money 40 years from now. We must account for the impact of inflation (the increase in the price of goods and services) on our dollars. If we input a long-term inflation rate of 2% into our calculator, the lower end of the RBA’s target band, my estimated $1,644,221 in 2057 means $730,051 in today’s money.

Now, some caveats. My calculator makes a lot of assumptions – namely that your wage will increase 2.5% annually for your entire career. Wages increases don’t work like this. Like returns, my assumptions are annualised. Salaries tend to lag, with bigger raises some years and stagnation in others.

Remember, superannuation is just one part of our total savings. Assets for funding retirement include any savings/investment we may have outside super including shares and property. Increasing your saving at least 20 per cent of your income is a good goal, particularly when you’re young and have the least amount of expenses.