What Really Makes Your Retirement Accounts Grow?
If you are like the average American you can expect to spend 20 years in retirement, according to the U.S. Department of Labor. Social Security might provide a basis for your retirement income, but it is hardly enough to allow you to retire in style. You might also have an employer-sponsored retirement plan or an individual retirement account. How fast those retirement accounts grow depends on what you invest in and how much time you have before you retire.
A retirement account is just an account. All it can do is hold your retirement assets. If there are no assets in your retirement account, it will not grow. The first thing you must do to make your retirement account grow is to contribute to it. If you have an employer-sponsored retirement plan, your employer might make contributions on your behalf. In some cases, such as with a 401(k) plan, your employer might allow you to contribute a percentage of your earnings into the account. Your employer might even match some of those funds. The more you contribute to your retirement account, the faster it will grow.
Some types of savings and investment products that you can hold in your retirement accounts produce income. This income might be in the form of interest, dividends, royalties or rental payments. This income might be deposited back into the original product or automatically reinvested into another type of product, which allows for compounding of your return. For example, if you have an individual retirement account that holds a number of different mutual funds, your trustee might automatically sweep any dividend payments into the fund family's money market fund, where that money will continue to earn interest until you decide to reinvest it elsewhere.
Your retirement accounts can grow due to capital appreciation of the assets in your account. For example, if you invest in stock and the market price of that stock increases, the value of your retirement account increases. If you sell that stock you receive a capital gain, but because retirement accounts typically are allowed to grow on a tax-deferred basis, you won't have to pay capital gains taxes on that transaction at that time. Depending on the type of retirement account, those gains might be taxed as ordinary income when you withdraw them, or, in the case of qualified distributions from a Roth IRA, they are not taxed at all.
The single most important factor in growing your retirement account is time. The more time you have, the larger your nest egg can grow. Having more time allows for downturns in the economy. The power of compound interest is fully revealed after significant amounts of time. It is never too early, or too late, to start saving toward your retirement, but the sooner you start the likelier you are to reach your retirement goals.
Mike Parker is a full-time writer, publisher and independent businessman. His background includes a career as an investments broker with such NYSE member firms as Edward Jones & Company, AG Edwards & Sons and Dean Witter. He helped launch DiscoverCard as one of the company's first merchant sales reps.