What is the best way to calculate, or just think about, the impact of a year of not earning income over the lifespan? I.e., assume you work from when you leave college to retirement and let’s assume, for simplicity, that this is 45 years (e.g., you start early by leaving college at 20 and retire a bit early at 65). If you stopped working and earning an income (other than returns on retirement accounts you already had) from your 30th birthday until your 31st (or whatever year you wish), and therefore could not make any contributions to your retirement or savings, what is the cost to you?
Let’s assume you don’t have any expenses…your aunt Matilda died and left you with exactly the amount you need to live on for one year so you do so and have nothing left of the inheritance, but also didn’t dip into any savings or make any contributions to savings. Or just the simple case of unemployment for one year with no benefits (or enough benefits to live on without tapping into savings or contributing to them). I chose 30 as the age since the earlier impact compounds, right?
If you wonder why I am asking, I’m wondering what the opportunity cost is for being in graduate school assuming no loans or costs and no impact on salary of graduate school (which is possible for people in some professions that go to graduate school for a year or two, e.g., fine arts, etc., and for people that switch careers, e.g., going into elementary school teaching from something more lucrative). Obviously the cost of loans and benefits on salary impact could be added next.
If all you’re concerned with is one year’s worth of contributions missing from your retirement nest egg, then the math is easy:
Missing a year at age 30, retiring at age 65, so n = 35. Assume annualized ROI of 7%. Assume missing contribution is $17,000. Future value of that $17K when you are 65 is:
F/P = $17,000 * 1.07[sup]35[/sup] = $181,501
Insert whatever values would apply to your particular case. It might be helpful to consider those dollar amounts in the context of the rest of your nest egg - for example, if you save $17,000 each year from age 31 to 65, then missing $181K from your nest egg at age 65, though noteworthy, wouldn’t be catastrophic.
It’s pretty easy to run retirement scenarios in an Excel spreadsheet. Lay out columns of numbers representing your age each year, your annual retirement contribution, the annual return, the total value of your nest egg, and set up the math for each year. Then you can change your annual contribution, your estimate of annualized rate of return, and so on, and see what happens to your nest egg. I have put together scenarios like this in Excel several times, trying different variations and seeing what the end results might be.
I’m not sure if it is relevant, but here goes anyway. When I think of my return to grad school, I considered the time to pay back the investment.
Pay lost from old job: $96,000 (4 years of about $24,000 per year)
Pay from assistantship in grad school: $48,000 (4 years of about $12,000 per year)
Loans: $50,000
Tuition: Covered by assistantship
So grad school cost me a total of about $100,000. My first job after grad school paid about $40,000 more than the job that I had prior to grad school. So the payback on my investment was about 2.5 years.