Confused about compound interest and diminishing returns

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abs9986
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Confused about compound interest and diminishing returns

Post by abs9986 » Mon Oct 22, 2018 9:47 am

I wanted to get your thoughts on early retirement and the diminishing returns of investing more and more money. This could also be a philosophical discussion.

I'm currently maxing both 401Ks and Roth IRAs as well as investing a sizable amount into a taxable account(s). What I'm noticing is that as I'm investing more and more into taxable, the "planned" retirement date for the given amount I need is hardly changing. For example, I just increased taxable another $6k/per year resulting in my family being able to retire ~ 1 year earlier. I understand why this is happening (less time for compound interest magic/more and more of the total value is principal), I think it just concerns me that due to the diminishing returns. Should I be rethinking my life/retirement philosophy? I know we're supposed to live within our means etc., but it's getting to the point where I'm sacrificing a lot of "fun" monthly money for very little gains in retiring earlier. I read this forum and MMM a lot - one could say that if I have all this extra to invest, then I should be able to lower my planned 25x expenses in retirement - I think my number is already reasonable and do not think it should be lowered ($65K in today's money given our annual expenses of ~$48K).

Other Considerations:
1. Pay off mortgage sooner (30 year, but currently making prepayments to pay off in 15)
2. Adequate emergency fund/cash savings = check
3. Adequate insurance (auto, liability, umbrella, etc.) = check


I'm just curious if anyone else has similar thoughts and/or struggles with this question.

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BolderBoy
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Re: Confused about compound interest and diminishing returns

Post by BolderBoy » Mon Oct 22, 2018 10:49 am

abs9986 wrote:
Mon Oct 22, 2018 9:47 am
For example, I just increased taxable another $6k/per year resulting in my family being able to retire ~ 1 year earlier.
Shaving a year off your otherwise required worklife is quite significant in terms of QoL. Unless you completely love your work (and it loves you back), few people maintain the, "can't wait to get to work tomorrow", attitude their entire lives. And the, "looking forward to work tomorrow", feeling ebbs ever moreso as you get older.

(from someone who, in his early working life, loved his work so much that he'd have done it without compensation, but realized that that "feeling" wasn't going to last forever)
"Never underestimate one's capacity to overestimate one's abilities" - The Dunning-Kruger Effect

RatherBeSailing
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Re: Confused about compound interest and diminishing returns

Post by RatherBeSailing » Mon Oct 22, 2018 12:32 pm

The main reason to pursue an early retirement is so that you can spend your time doing things you enjoy. If you enjoy your work, stop stressing about leaving it and enjoy your life. If you hate your work, start looking for another job. I see the drive for early retirement to be largely a navel gazing exercise. Very few actually quit all forms of remunerative work... most just settle into jobs that are far more enjoyable.
MMM would label me as the Internet Retirement Police but let’s not kid ourselves... you don’t need 25x savings to do a career change to something more enjoyable.

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Kenkat
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Re: Confused about compound interest and diminishing returns

Post by Kenkat » Mon Oct 22, 2018 12:42 pm

What I have found is that once your portfolio gets to a certain level, incremental savings doesn’t make a lot of difference. I have had single days where my portfolio goes up or down more than my entire 401k contribution for the year. Last year, my investments increased by more than my entire salary for the year. Once your portfolio reaches a certain size, the die has been cast to a large extent. Of course, if another $6k of savings can get you to retirement a year earlier, that’s a pretty good deal. I would save as much as you can while you are young, but within reason. It’s ok to spend some money on current consumption if your savings goals will get you to where you want to be someday.
Last edited by Kenkat on Mon Oct 22, 2018 4:42 pm, edited 1 time in total.

abs9986
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Re: Confused about compound interest and diminishing returns

Post by abs9986 » Mon Oct 22, 2018 2:24 pm

I guess my thoughts are more the "diminishing" returns of investing more. I'm curious if others get to a point where they say, investing more isn't worth it...it's only allowing me to retire 2 months error for the same $6K.

ResearchMed
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Re: Confused about compound interest and diminishing returns

Post by ResearchMed » Mon Oct 22, 2018 4:07 pm

abs9986 wrote:
Mon Oct 22, 2018 2:24 pm
I guess my thoughts are more the "diminishing" returns of investing more. I'm curious if others get to a point where they say, investing more isn't worth it...it's only allowing me to retire 2 months error for the same $6K.
It depends in part on *when* you add that, for example, $6k.
If you add it at age 59, that's very different than adding the same "extra" at something like at 27 or 35, in terms of time for compounding.

RM
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One Ping
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Re: Confused about compound interest and diminishing returns

Post by One Ping » Mon Oct 22, 2018 8:06 pm

abs9986 wrote:
Mon Oct 22, 2018 2:24 pm
I guess my thoughts are more the "diminishing" returns of investing more. I'm curious if others get to a point where they say, investing more isn't worth it...it's only allowing me to retire 2 months error for the same $6K.
One way to maybe think about this is that the $6K you invest today has 30 years to grow. At 6% CAGR it will be $35K. That might be a significant part of a years expenses. Just another way to think about it.
"Re-verify our range to target ... one ping only."

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#Cruncher
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Re: Confused about compound interest and diminishing returns

Post by #Cruncher » Tue Oct 23, 2018 8:20 pm

BolderBoy wrote:
Mon Oct 22, 2018 10:49 am
abs9986 wrote:
Mon Oct 22, 2018 9:47 am
For example, I just increased taxable another $6k/per year resulting in my family being able to retire ~ 1 year earlier.
Shaving a year off your otherwise required worklife is quite significant in terms of QoL [quality of life].
One year seems like a lot to me also. In the following example continuing a $6,000 annual investment one more year at age 58 reduces the time to reach a $400,000 target by only 1/2 year (178 days). My illustration assumes an inflation-indexed $6,000 invested at the end of every year beginning at age 30 and growing at a real rate of 4%.

Code: Select all

    ColA  Col B     Col C    Col D      Col E   Col F
                  Contrib  -- Reach Target --   Fewer
Row  Age   Year  Grows To   Years      Date      Days

Code: Select all

  5   30   1990     6,000  107.079   Jan 2098
  6   31   1991    12,240   88.901   Nov 2080   6,275
  7   32   1992    18,730   78.055   Jan 2071   3,596
  8   33   1993    25,479   70.208   Mar 2064   2,500
  9   34   1994    32,498   64.004   Jan 2059   1,901
 10   35   1995    39,798   58.838   Nov 2054   1,523
 11   36   1996    47,390   54.386   May 2051   1,260
 12   37   1997    55,285   50.457   Jun 2048   1,070
 13   38   1998    63,497   46.926   Dec 2045     924
 14   39   1999    72,037   43.709   Sep 2043     810
 15   40   2000    80,918   40.744   Sep 2041     717
 16   41   2001    90,155   37.988   Dec 2039     642
 17   42   2002    99,761   35.407   May 2038     578
 18   43   2003   109,751   32.974   Dec 2036     523
 19   44   2004   120,142   30.667   Sep 2035     477
 20   45   2005   130,947   28.471   Jun 2034     437
 21   46   2006   142,185   26.372   May 2033     402
 22   47   2007   153,872   24.358   May 2032     370
 23   48   2008   166,027   22.420   Jun 2031     342
 24   49   2009   178,668   20.549   Jul 2030     319
 25   50   2010   191,815   18.738   Sep 2029     296
 26   51   2011   205,488   16.983   Dec 2028     276
 27   52   2012   219,707   15.277   Apr 2028     257
 28   53   2013   234,496   13.616   Aug 2027     242
 29   54   2014   249,875   11.996   Dec 2026     226
 30   55   2015   265,870   10.414   May 2026     213
 31   56   2016   282,505    8.867   Nov 2025     199
 32   57   2017   299,805    7.351  5/08/2025     189
 33   58   2018   317,798    5.866 11/11/2024     178 *
 34   59   2019   336,510    4.407   May 2024     167
 35   60   2020   355,970    2.973   Dec 2023     158
 36   61   2021   376,209    1.563   Jul 2023     150
 37   62   2022   397,257    0.175   Mar 2023     142
* Calculations for age 58 using Excel FV and NPER (or LN) functions:

Code: Select all

 317,798 =   FV(4%,        2018 - 1990 + 1, -6000, 0,              0) or
 317,798 = 6000 * (1.04 ^ (2018 - 1990 + 1) - 1) / 0.04
   5.866 = NPER(4%,                          0,   -317798, 400000, 0) or
   5.866 =   LN(400000 / 317798) / LN(1.04)
11/11/24 = 5.866 * 365.25   + DATE(2018, 12, 31)
     178 = DATE(2025, 5, 8) - DATE(2024, 11, 11)
To repeat the calculation with other assumptions, select all, copy, and paste [*] the following at cell A1 of an empty Excel sheet; format for readability (e.g., date in cell E5:E6); and copy row 6 down.

Code: Select all

Annual contribution	6000
Target	400000
Return	0.04
Age	Year	Grows to	Yrs to Target	Date	Days
30	1990	=FV(B$3,$B5-$B$5+1,-B$1,0,0)	=NPER(B$3,0,-C5,B$2,0)	=ROUND(DATE($B5,12,31)+D5*365.25,0)
=A5+1	=B5+1	=FV(B$3,$B6-$B$5+1,-B$1,0,0)	=NPER(B$3,0,-C6,B$2,0)	=ROUND(DATE($B6,12,31)+D6*365.25,0)	=E5-E6
* If you have trouble pasting, try "Paste Special" and "Text".

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