The Very High Cost of Waiting to Save for Retirement
This is the story of two friends – one, we’ll call Randy, who, at age 25, recognized the importance of starting a retirement savings program. The other is Peter, same age, but he couldn’t seem to see beyond his need for more immediate gratification – wanting to experience the kind of life style enjoyed by his more highly compensated friends.
Randy, decided to establish a 401k account and begin saving $800 per month, about $10,000 a year in a diversified portfolio of mutual funds which generated an average annual return of 6 percent. At age 45, Randy was forced to stop working due to health reasons, so he collected disability insurance benefits and stopped contributing to his 401k account. After 20 years of investing, his retirement account had grown to just over $360,000.
Of course, Peter decided to wait before getting serious about saving for retirement. A part of his rationale was that he would be making more money later on, which would allow him to catch up with bigger monthly contributions. In fact, Peter waited until his age 45 to begin saving, about the same time that Randy stopped contributing to his plan. With 20 years left to save, Peter figured he would have plenty of time to build his nest egg. However, unable to adjust his lifestyle as much as he needed, he was only able to commit to an $800 a month savings plan. He too invested in a portfolio of mutual funds and was able to generate an average annual return of 6 percent. After 20 years, his account value grew to $360,000.
So, here we have two friends – the same age; contributing the same amount of money; and earning the same rate of return. One started saving early, and the other waited. But wait! While Peter was making his contributions, Randy’s account continued to grow in value, even without new contributions. In fact, by the time they both turned 65, Randy’s account had grown to nearly $1.2 million! Same amount invested; same return on investments. The only difference – and it is a monumental difference - is how they utilized their most valuable asset – time.
Yes, There is a Cost for Waiting
The moral of the story is that we all have, roughly, the same amount of time – from the time we start working to the time we would like to retire. Yet, not everyone recognizes that time is not only our most valuable asset, it’s also a wasting asset. Peter, and everyone else who believes there is going to be enough time, proved that there is an actual cost of waiting.
Peter could have “caught up” to Randy; however he would have had to save more than four times as much and/or assumed a much more risk to earn a higher return. Essentially, the more time you have, the less it will cost you to achieve your goals. Time can also mitigate risk, enabling us to assume less of it because of the longer span of time that our money can work for us. We all start out with more time than money, which is why it’s important to start saving early.
Embrace the Magic of Compounding Returns
As the great Albert Einstein once said, “the power of compound interest is the most powerful force in the universe” and “the greatest mathematical discovery of all time."
The “magic” of compounding returns stems from the fact that your money not only earns a return on the principle; it also earns a return on the returns that are earned. Of course, there can be no magic without time. The “time value of money” is the absolute key to the magic of compounding returns. When the compounding effect of returns earned is combined with time, the growth of your money at work becomes exponential, as in the case of the penny. Time and compounding returns can turn even the smallest amounts of savings into significant.