The secret is to start saving now – because when it comes to saving for retirement, time really is money.
The reason for this is that the more time you have to save money the faster it will accumulate each year. For example, if you invest $5,000 and it earns 6% a year, at the end of the first year you will have $5,300 ($5,000 x 1.06 = $5,300). If this investment also earns 6% the next year, then you will have $5,618 at the end of the second year ($5,300 x 1.06 = $5,618).
In this example, notice that you earned more interest in the second year than in the first year – $318 versus $300. Because of this, your effective interest rate over the 2 years was 12.4%, rather than the 12% you would get by just multiplying 6% by 2 years.
This happened because in the second year you were earning interest on the previous year’s interest. Earning interest on interest in called compound interest.
Although the difference made by compounding may look small in this example, as the years pass, the compound interest on your investments will grow exponentially, earning far more than you might think is possible.
Let’s look at an example of the power of compound interest:
- Starting at age 35, Faye Provider saves $2,000 a year for ten years, investing a total of $20,000. Although she stops contributing, her investments continue to grow, earning 8% per year. After 30 years, at age 65, she will have $135,042 in her retirement account.
- Starting at age 45, Faye’s twin brother Fred saves $2,000 a year for 20 years, investing a total of $40,000. His investments also earn 8% per year. At age 65, he will have $91,524 in his retirement account.
Although Fred saved twice as much as Faye, he ended up with about one-third less money than she did when they both reached age 65. The reason for this shortfall is that he waited 10 more years before he started to save!
The compounding of interest over time is what causes money to grow exponentially the longer it is invested. Because of this, the best time to start investing your money for retirement is – today! An the next best time is – tomorrow! The younger you are when you start investing, the more time your investments will have to accumulate, and the more you will benefit from compounding.
Here’s another dramatic example: If you start investing $3,000 a year on your 35th birthday and earn 8% each year, you will have $339,850 when you reach age 65.
But, if you decide to put it off and wait just one more year to start investing (until your 36th birthday), your balance at retirement would fall to $311,898. By putting off your $3,000 savings for one year, you have lost $27,952 for your retirement.
This example illustrates the high cost of procrastinating. But what if you’re not that young anymore?
Some people who are nearer to retirement don’t start investing because they figure that they just don’t have enough time for it to make a difference. But it’s never too late in life to begin saving!
If you are now age 52 and you start saving $50 a week in a tax-deferred investment that earns 8% per year, you will have $104,521 at age 70.
Start investing so your hard-earned money will work even harder for you.
Note: I used the example of 6% and 8% investment return in this article. Your return can be very different. Over many years, the average return of stock investments is about 10%, although most experts anticipate a lower than average return in the coming years.
Tom Copeland – www.tomcopelandblog.com
Image credit: https://www.flickr.com/photos/68751915@N05/
For more information about saving for retirement, see my book Family Child Care Money Management & Retirement Guide from which this article was taken.