Deciding when to start saving for your future is equally if not more important than deciding how much to save. Saving a little now is more valuable than putting a lot aside later, even if it doesn’t seem that way. Let’s say you want to save $1 million by the time you turn 65 (and really you should be saving even more.) If you start saving at age 25, and with a seven percent rate of return annually you will need to put aside $416 per month to reach your goal.
Unfortunately, the typical 25-year-old is too consumed by student loan debt or a job that isn’t quite paying as much as they’d like, and the thought of saving more than $400 every month may seem unfathomable. Fast forward 20 years to an established 45-year-old who is comfortable and feels as if they have the money to start saving for retirement. At the same seven percent rate of return, you will have to start saving roughly $2,000 per month to reach your $1 million goal by the age of 65.
Why the drastic difference in monthly savings for the same outcome? It’s the magic of compound interest. Over time, a slow and steady rate of compound interest can build into a profitable investment. The most lucrative investments have steady, compounded returns.
Investopedia defines this magical concept as the “interest calculated on the [original amount owed] and also on the accumulated interest of previous periods of a deposit or loan.” In more simple terms, it’s the interest earning interest. For example, if you put aside $500 a year ago, and let’s say during that period it earned $10 in interest. Now this year, you’ll be earning interest on the original savings plus the interest earned which is now $510. Understanding this concept can help your investments grow exponentially in a shorter period of time.
Compared to simple interest, which rewards you with a fixed amount based on the original investment, compound interest is a more valuable option. The rate at which compound interest accrues depends on the number of times it compounds. The higher the number of compounding periods means the compound interest will also be higher. For example, in a one year time period the amount of compound interest accrued on $100 compounded at ten percent annually will be lower than that on $100 compounded at five percent semi-annually (2x per year).
Apart from the numbers and percentages it is important to save while you are young because when you aren’t saving money you are likely spending it! When you make the commitment to save as much as possible as soon as possible, you will gradually cut out things you don’t need. Eric McMullen, managing director at Canter Strategic Wealth Management, suggests you start saving with pennies then move to dollars if you find it hard to cut corners.
For example, if you buy something for $3.89 then record it in the checkbook as -$4.00. Keep track of the extra .11 cents and deposit it at the end of the month into a savings account. In the future, when something costs $8 round it to $10 and deposit the remaining $2 at the end of the month. After taking a close look at your regular spending, you will find it easier and easier to set money aside over time. Additionally, creating a strict budget when you are in your younger years will prevent you from essentially wasting money in the future.
Investing early also gives you room to take bigger risks with your portfolio. Never underestimate the power of knowing that you have time on your side to weather a rocky market. By saving early you have more time to recover if the market goes down and you will have created a comfortable future for yourself. Planning a sound investment strategy now means you won’t have to live paycheck-to-paycheck later in life and this could result in a confidence boost within your family and even in the workplace!
Most importantly, Eric McMullen suggests educating yourself on what matters to you. If you are concerned with growing your money then he suggests reading about growth strategies. all too often people try to learn everything about the market, which can be overwhelming by reading about all the countless products and strategies. Keep it simple and don’t get concerned with all the noise. While it may seem gratuitous to start saving for retirement at such a young age, now is really the best time to get started.
The earlier you start putting money aside to invest; the better off you’ll be in the future. Getting started in your 20’s allows the compound interest plenty of time to accumulate and grow into a nice bundle for you, so take advantage of it while you can.
One final question— What are you waiting for?
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