Did you find yourself dreaming of
umbrella drinks and cabana boys walking along the beach or relaxing in a hammock or something else that says “I don’t have to work anymore”? Let me put it this way. If you didn’t see yourself as a greeter at Walmart, then you need a plan for saving your nest egg. How much you should save and what your end goals should be is the topic of another post. For today, we are focused on when you should start saving regardless of how much or how little you may have.
Making Money with Money
You may or may not be familiar with the concept of compound interest. If you are familiar, it is always good to have a refresher and a reminder about its power. If you aren’t familiar then you must pay attention. Compound interest is a powerful tool and one of the easiest ways to earn money over time.
Compound interest boils down to this:
- Earn interest on your savings.
- Then earn interest on the interest you earned.
- Repeat over time.
End result? Snowball effect and more money in your pocket.
How Much Does Compound Interest Affect Your Bottom Line?
- Two people – Interest Ike and Bury it Bernie – each save $25 per month for retirement from the time they are 30 until they are 60.
- Interest Ike puts his in a bank account that pays a 5% annual interest rate while Bury it Bernie puts his in a coffee can and buries it in his backyard. (Bury it Bernie may or may not live in a cabin in the woods with an outhouse. Oh, and disclaimer – any resemblance to
my familyreal life is purely coincidental.)
Ahem, back to the topic.
How much more does Interest Ike have than Bury it Bernie at the end?
- Interest Ike = $20,893.16
- Bury it Bernie = $9,000
- Difference = $11,893.16
Interest Ike has 232% more than Bury it Bernie at the end of 30 years. Let me say that again 232% more. Ike has more than double what Bernie saved – and that’s just assuming a 5% annual return on investment (ROI). You can use a compound interest calculator to play with the interest rate, monthly deposit amount, and length of time to see how they all affect the outcome. But I will tell you the answer up front:
Time is the Secret to Compound Interest & Retirement
Assume Interest Ike is a daredevil and doesn’t think he’ll live until retirement so doesn’t start thinking about saving until he’s 40. Then he
stops partying realizes he’s old and broke going to make it, so starts saving. He contributes the same amount of money ($25 per month) at the same interest rate (5%), but for 20 years.
How much will losing those few years cost him?
- $25/mo for 30 years = $20,893.16
- $25/mo for 20 years = $10,318.66
- Difference = $10,574.50
Starting late cost Interest Ike double! He has less than 1/2 of what he would have had if he had only started 10 years sooner.
Maybe you noticed that there are 10 years of $25 per month that weren’t considered in the above scenario. Maybe you’re saying to yourself that clearly Ike will have less, because he didn’t invest that other $3,000 during the previous 10 years. You could be thinking Ike should just put a lump sum of $3,000 in the first year and catch up. This might even be a strategy you’ve considered for building your retirement nest egg.
Let’s see how that plays out for Ike.
What happens if Ike puts a lump sum of $3,000 in up front and then continues to add $25 per month for 20 years? His total money in would be the same as if he had started adding $25 for 30 years. Will his money out be the same?
- $25 per month for 30 years (total invested $9,000) = Total return of $20,893.16
- $3,000 up front then $25/mo for 20yrs (total invested $9,000) = Total return of $18,456.58
- Difference = $2,436.58
Nope, Ike still has 12% less than if he had just started sooner.
Are you convinced yet?
For those of you that
are hanging onto your excuses may still be skeptical, let’s consider the following scenario:
Imagine if Ike started investing $25/mo when he was 25, retired at 65, and averaged 11.61% (the average rate of return of the S&P 500 for the most recent 40 years -1970 to 2010)
Now are you convinced?
So, When Should You Start Saving for Retirement?
My answer is yesterday. But since that’s already passed, start now. Even if it’s just $25 per month, the sooner you start saving, the better off you’ll be in the long run. If you don’t have an extra $25, then start clipping coupons to save on groceries, pick up a mystery shopping gig, babysit one night a month, set up a lemonade stand, eat at home instead of eating out one night a month…
You can find $25 a month. And if you are already putting aside $25, then bump it up to $50. Whatever the dollar amount is, start saving it now – not next month or next year. Now.
Are you saving for retirement? If not, what’s holding you back?
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