Participant education meetings have long touted the "magic" of compounding: that apparent miracle of finance whereby income earned on investments becomes part of an account balance, and earns more income that, in turn, adds to the account balance, which earns more income, and so on. The net result, of course, is that, at the end of a savings career, you wind up with a lot more money than you ever thought possible.
We all know that compounding is a good thing—something that works on our behalf even when we aren't doing anything. Sort of like having a good metabolism that keeps your portfolio in fighting trim without requiring any physical exertion (I still remember those days fondly). As a consequence, we tend to take it for granted.
In the "real" world, nothing moves in a consistently positive direction. Investment returns generally are unpredictable, if not downright volatile; contributions (even "escalated" designs) tend to plateau at some point; and account balances are depleted, for a time anyway, by things like loans and withdrawals.
However, the message—that your investments keep working for you even after you quit working—is timeless, and one well worth keeping in mind as you help participants work toward a financially secure retirement. —Nevin E. Adams, JD
Editor's Note: The focus of compounding in participant meetings—and of this month's KnowHow—is generally on the impact compounding has on helping build up your retirement savings. It is worth noting, however, that a recent white paper by Russell Investments, "The 10/30/60 Rule: Where Do Defined Contribution (DC) Plan Benefits Come From? It's Not Where You Think," indicated that nearly 60% of one's total retirement distribution can come from investment returns attained after retirement (age 65 in the example). How much comes from individual contributions? Well, in the Russell example, a relatively miniscule 10%, and the rest from pre-retirement earnings—about 30%.