The average worker in America has 6.2% in Social Security taxes withheld from each paycheck. This money is given to the government with the understanding that it will be returned to the worker in his or her retirement years for living expenses via a set monthly payment.
However, is it possible for an individual to earn more money for retirement than the government would pay by investing that same 6% on his own?
I recently came across an interesting hypothetical scenario that says that it is indeed an achievable possibility. On his radio show last week, personal money management expert Dave Ramsey outlined a compelling case for the power of compounded returns in long term investing.
He said it is not only possible for an individual to earn better returns than Social Security, but that one can in fact end up with far more money in retirement by investing a set amount each month over the course of a working lifetime.
Here was the scenario as Ramsey presented it:
He assumed that an individual who works 40 hours per week makes $8 per hour. That would amount to $1280 earned each month (40 hours x $8 x 4 weeks/month). The portion you pay into Social Security is 6% (rounded off), so that represents $76.80 of that monthly $1280.
Ramsey then states:
“If you make $8/hr your entire life and you were to save $76 a month from age 20 to age 70, your working lifetime – 50 years, and you did that in a decent growth stock mutual fund, here’s what you would have: you would have $3 million at your death, which by the way if you were to live on 8% of $3 million, you would have an income at retirement at 70 years old of $20,000 a month having never made more than $1200 a month. If I’m half wrong, I would have to be 90% wrong, to get down to the [monthly amount paid by the] Social Security system.”
Ramsey also added that when you die, your family doesn’t get anything from Social Security, but if you die with $3 million in savings, it is passed along as an inheritance which will help your surviving family members.
He also pointed out that this example assumes the person makes $8 an hour his entire life with no raise, an unlikely scenario since most employees will get several raises over the course of their lifetimes. The incremental raises would of course allow for saving even more each month since the employee’s income would be greater, thus potentially pushing the $3 million dollar ending balance up much farther.
What kind of a mutual fund is Ramsey talking about in his example? He routinely says that he looks for growth stock mutual funds with long (10 year or more) track records that show the fund has earned, on average,12% or more each year over its lifetime. He even provided examples of two such funds recently, The Investment Company of America Growth and Income Fund and The Growth Fund of America.
Federal employees have the TSP at their disposal to help them invest in precisely the same manner that Ramsey is advocating. Regular contributions from their paychecks go into the funds, and for FERS employees, the government will even offer some matching contributions to boost the regular contribution amounts. This can amount to big returns over the course of a federal career. Y9u can look at the annual returns of the TSP funds going back as far as 1988 to get a feel for how they perform long term.
But can the slow and steady approach to the TSP create millionaires? Some federal employees have done it – see 208 TSP Millionaires Enjoy a Big Return in January.