Early to bed and early to rise makes man healthy, wealthy and wise.
Early to save and early to invest makes him financially healthy, wealthy and nice.
Many youngsters who are still in their 20’s and 30’s or who have just started their career think little about saving for retirement let alone planning for it. Who on earth thinks and plans for something that is going to happen 30-40 years down the line? However, saving for retirement is absolutely necessary and the sooner you start, the better you are.
Building big enough retirement nest egg depends on 3 factors: how much you save, how long you save and how much returns you get. In short – amount, time, and rate of return. Beginning to save in the early days has some important advantages that you cannot ignore. They are:
- Magic of compounding
- Ability to take risk and invest aggressively
- Opportunity to learn and correct the mistakes
Magic of compounding
“Compound interest is the eighth wonder of the world. He, who understands it, earns it … he who doesn’t … pays it.” ― Albert Einstein.
In simple terms, earning compound interest means earning the interest on the interest earned. Year after year, the amount (i.e., principal amount + interest earned) accumulates and thus can have a big enough lump sum with which you can retire comfortably. On the other hand, those who start saving later in life or while nearing their retirement, do not have the time advantage and therefore cannot invest (and reinvest) their money for a longer period; they, therefore, have to save more to meet their retirement goals which would certainly impact their lifestyle.
Let us analyze this with an illustration:
Steve, John and Tim are friends and all of them start their career at the age of 25.
- Steve begins saving at 25 and invests $5,000 each year in a Roth IRA for next 10 years and then stops investing altogether. (i.e ., he invested $50,000)
- John begins saving only at 35 and invests $5,000 each year for next 30 years until he is 65. (i.e., he invested $150,000)
- Tim begins saving only at 45 and invests $10,000 each year for next 20 years until he is 65. (i.e., he invested $200,000)
When they turn 65, assuming 8% return on their investments, Steve will get $787,000, John will get $611,000 and Tim will get only $494,000. That’s the magic of compounding! While John had to make adjustments to his lifestyle for 30 years and Tim had to save aggressively for 20 years until retirement, Steve saved only for his first 10 years and still ended up with a bigger nest egg compared to his friends. You might as well say Steve has an unfair advantage!
|When did he start saving?||How much did he save each year?||How many years did he save?||What is the total investment amount?||What is his Nest Egg at age 65?|
That’s why Albert Einstein rightly called compound interest “the greatest mathematical discovery of all time”.
Ability to take risk and invest aggressively
Rate of return earned on investments is another factor which has a huge impact on financial status of an individual. Rate of return varies because of market volatility and it severely impacts the return on investments. Though individual investors cannot control this, those who started early can go for high risk investments and invest aggressively where they can expect high returns and can withstand any market fluctuations.
Peter Lynch, one of the greatest investors of all time, has said that the “key organ for investing is the stomach, not the brain”. Young investors can bear the change in market conditions. Those who start late do not have much runway to be able to take higher risk and withstand any negative market impact. They are in need of the money sooner than those who invest early and wait.
Opportunity to learn and correct the mistakes
Young investors are tech savvy and can zealously explore and learn the various investment options and products. They have the luxury of experimenting with new ventures and can afford to be adventurous. They can make errors of judgment and still have time to recover from their mistakes. Since they are still earning, there is minimal impact to their financial worth, in the long run, when such mistakes occur.
When it comes to the question of saving for retirement it’s never too early (or too late!). Along with aforementioned advantages, if you start saving early – however small the amount may be – you will get it into the habit of saving. It will enable you to achieve your retirement goals easily without many sacrifices during your work period. Postponing indulgences today will enable you to pay the bills tomorrow. Money saved is money earned.
So start early, spend wisely and save diligently.