Retirement Savings and the Rule of 72s

What pastors and church staff can learn about the power of compounding.

Pastors and church staff often are overwhelmed by the thought of setting aside money for their future retirements. But the sooner they start, the quicker they can make the money they save and invest work to their advantage.

This is because of the concept of compounding. It works like this: Your rate of return can rise exponentially based on the investment of your earnings over the long-term horizon. It’s remarkable how that money will grow over 20, 25, or more years. And if that money is placed in a 403(b) account, which many clergy and church leaders use, it grows tax-deferred. In other words, you have tax-free earnings and the compounding of your investment in most cases.

To visualize the kinds of returns that are possible, it’s helpful to understand the concept of the rule of 72s. Under this rule, any amount of money doubles in 72 divided by your rate of return. For example, let’s say you have $1,000 that you’re going to invest at age 30, and let’s say you can get a 9 percent rate of return or interest on that $1,000. That amount will double in eight years. So at the age of 38, your $1,000 is now $2,000. At age 46, it doubles again—from $2,000 to $4,000. It continues to double again at ages 54, 62, and 70. If you can leave that money alone and rely on other income streams until you’re 78, the original amount of $1,000 will have grown to $32,000. It’s remarkable.

The bottom line to this is to make time work in your favor. The problem, of course, is that it is difficult to afford a large, lump-sum contribution at the age of 25 or 30. Yet those are the ages at which compounding can really have the significant impact. So what can pastors and church staff do early in their careers? Start saving something, even $100 a month, into something like a 403(b). When you’re in your 20s or early to mid-30s, that money is going to work for you for a long time, and that compounding effect is going to work in your favor. Starting after those ages can still reap rewards—obviously to a lesser degree, since less time is involved—but it’s still worth doing.

You may ask, “Well, how can I get a 9 percent rate of interest to have my money double every 8 years?” Here’s what’s interesting. Since 1900—the past 120 years or so—the average rate of return on the stock market has been about 9 percent. Of course, the past doesn’t determine the future. But that’s a good track record for a nearly 120-year period. And if you look at the rolling averages in 10-year cycles, starting from 1900 (so 1900 to 1910, 1901 to 1911, and so on), it turns out—and this is interesting—that 43 percent of those 10-year periods had a rate of return that was less than 8 percent, but 22 percent had a rate of return that was 8 to 12 percent. And in 35 percent of those periods, the rate of return increased by more than 12 percent.

If you take all of these rolling averages—these 117 10-year rolling periods of time—the total average was 10 percent for that entire period of time. So earning an average rate of return of 10 percent is not necessarily unrealistic. It is, of course, if you’re putting your money in a bank account or a certificate of deposit today, but not if you’re putting it into a 403(b) or similar type of investment.

The thought of placing savings into an investment account may sound risky, even with this track record of average rates of return. But that fear is likely misguided. I read an article in a financial magazine years ago—I’ve never forgotten it. The author interviewed a number of retirees from a variety of professions. One of the questions was “What was your biggest regret in preparing for your retirement?” Far and away, the most common response was something like this: “I was not aggressive enough with my investments. I was too timid in exposing any asset to risk.”

Psychological studies have shown that the pain of loss in the stock market is more powerful than the joy of gains. So if you have a year where the rate of return is up 15 to 20 percent, you’re jubilant. But that’s a less intense emotion than the anguish you experience when you lose money, and that tends to make people timid.

That’s why it’s critical to keep the long-term horizon in view. It works in your favor. Yes, there are some 3- or 5-year rolling averages where the stock market goes into negative territory, but not for any 10-year period over the last nearly 120 years.

Go deeper on retirement planning for pastors and church leaders with the articles “Retirement Planning for Pastors” and “Taking the Right Steps to Establish a Retirement Plan.”

Richard R. Hammar is an attorney, CPA and author specializing in legal and tax issues for churches and clergy.

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