We’ve probably all heard the story and seen the math, how if today’s newly retired senior citizen had invested a one-time lump-sum of $10,000 in the Dow Jones Industrial Average Index in 1960 when they were say 25 years old and let it compound for 40 years, it would be worth $736,843 at the end of 1999. This is a compounded return of 11.35%. If you have not seen that particular example you may have seen something similar in a mutual fund advertisement, perhaps showing an even more dramatic growth if the fund happened to beat the DOW. For example if a fund achieved a compounded 14% return over the 40 years, the original $10,000 would be worth $1,888,835.

But there is a major problem with this scenario. The average wage in 1960 was $4080 per year (Note that United States figures are used throughout this article). So expecting someone to have invested $10,000 in 1960 is to expect them to have invested about 2.5 times their annual gross salary in a lump sum at age 25. This is clearly not realistic. At age 25 most people have little or no savings. In 1960 a typical 25 year old probably had a mortgage or may have been saving for a house. There is no way that very many 25 years could have found $10,000, or anything close to that amount, to invest for the long term.

So these types of scenarios are totally unrealistic. You can stop beating up on the seniors in your family about why they did not invest $10,000 40 years ago.

The other scenario we often hear about is the 10% solution, that you will be wealthy if you save and invest 10% of your gross salary over your career. In order to explore this, I analyzed data using the actual average salary level back to 1950.

The table below shows the results of the median male U.S wage earner investing 10% of gross salary into the Dow Jones Industrial Average with all dividends reinvested. The results are shown for 12 different recent 40 year periods.

Note that the average wage is based on the median for males and was U.S. $27,275 in 1999. This analysis assumes the investment is in a tax deferred plan and ignores broker commissions or other advisor costs.

The median male U.S. wage earner could have become relatively wealthy with this 10% solution, applied for 40 years. For example, the 1997 retiree would have had a portfolio worth $642,589 ($667,005 in 1999 dollars). This is over 26 times the median wage in 1997. Not bad at all for someone who earned the median wage all those years.

A retiree in 1990 did not fare quite as as well. The 1990 retiree had a portfolio worth $255,986 ($326,299 in 1999 dollars). This is over 12 times the median wage if 1990 which was $20,293.

So, it does appear that by investing 10% of your gross wages for 40 years, you might expect to build up a fortune of some 10 to 30 times your annual wage level. So, the 10% solution does seem to work, if applied for 40 years.

But realistically, most people are going to be net debtors well into their 30’s or beyond. Investing 10% of gross income may not be possible when paying a mortgage and perhaps paying a student loan. Also many people have a goal of retiring at age 55. Both factors tend to reduce the number of years available to build a retirement portfolio.

The data below presents the results of applying the 10% saving rule to people who retired in each of the last 22 years and who invested for 30 years. Again, this is based on the actual median income for males in the U.S. and actual total return (with dividends reinvested) from the Dow Jones Industrial Average.

Retirees in each of the last five years would have done quite well indeed using the 10% solution for 30 years. These people could have accumulated a nest egg worth 15 to 22 times their final salary level. That constitutes a pretty wealthy position particularly in combination with other sources of retirement income.

But, retirees through the 80’s and early 90’s would not have found great wealth with the 10% solution. In some cases the nest egg is as little as 3.5 times the final salary level. The number of cases in which the final nest egg is less than 6 times the ending salary level should come as a sobering shock to anyone who thinks that it is possible to accumulate say $1,000,000 by investing 10% annually of a $50,000 salary for 30 years.

The lesson here is that saving 10% of gross salary for 30 years does not guarantee a particularly wealthy retirement. In some cases it was enough, in other time periods it would have proven insufficient.

It seems clear that investors need to start saving as early as possible and that they should try to save more than 10% if possible.

Every investor’s situation is unique, many investors can expect to start out below the mean salary level but may end out their career far above the mean salary level. Most investors will not invest exactly 10% each year but will invest less in the early years and more as they near retirement. But the above scenario can help you to set a realistic goal for your retirement fund, based on real results from the Dow Jones Industrial Average and based on real wage levels. This should be better than trying to set your goals based on patently unrealistic scenarios such as investing a huge lump-sum at age 25.