Putting money aside for retirement is crucial. Everyone knows how important saving for retirement is, but we often underestimate how important it is to start saving as early as possible.
One of the best lessons anyone can learn is the power of compound interest. Compound interest is one of, if not the, most powerful tool that any investor can use to grow his or her retirement savings account.
Compound interest occurs when interested earned is added to principal, therefore earning its own interest in the future.
Albert Einstein once referred to compound interest as “the greatest mathematical discovery of all time.” It may not be the most impressive mathematical discovery the world has ever seen, but it could easily be the most important, because you can apply it to your everyday life… in particular to your retirement account.
It is a pretty simple concept. Say you invest $10,000 today, and are able to earn 4% annually on your investment. At the end of the first year you have earned $400 on your original $10,000. Reinvesting that $400 now gives you a principal amount of $10,400. As a result, in your second year, you earn $416.
A lot of people will look at that and think to themselves that the extra $16 is not enough money to get them excited about compound interest. But what effort did it take to earn that extra $16? None. And once you start to extend this example out to 10 or 15 years, the numbers get very impressive.
In the tenth year, the original $400 annual earnings would have risen to $569 a year. By the 15th year, the annual income would be $692, and by the 19th year your annual income would double to $810 annually, and your account would total.
Simply put, interest on interest is the best way to build your savings.
As you can see, compound interest is a powerful tool, but it takes two things to make it work. The first being time, and the second being reinvestment of earnings.
Setting up your portfolio to reinvest earnings is simple enough, and something you can do at any time… but there is no way to get back lost time. The sooner you start, the quicker compound interest starts to work for you. Over time, you can see huge benefits from reinvesting your earnings, but individuals starting at 25 will see much greater benefits than people who begin saving at 35.
To expand this example, let’s say investor A starts at age 25, while investor B starts at 35. Both invest $10,000 and both get 4% annually.
By age 50, investor A has $26,658. Investor B, on the other hand, has $18,009. The extra 10 years has bought investor B an extra $8,650.
Another powerful way to plan for the future is with employer-sponsored plans that match a certain percentage of the money you invest. This is a lesson that I learned early in my career.
The first company I worked for had a policy of matching 75%, up to a set amount, of money I set aside for retirement each month. Since I was starting out, and was in my early 20’s, I decided to forgo savings for a couple of years until I was earning enough not to miss any contributions I made.
Luckily for me, our CPA came to me and explained what a big mistake this would be. Even if I set aside $100 a month, that would give me a FREE $75 each month. It may not seem like a lot, but there is no other investment you will ever make in life with a guaranteed 75% return.
I followed his advice, and was amazed at just how quickly that $100 a month grew. Over time I was able to increase my monthly savings, and with the 75% match the funds grew quickly. Had I put off those savings, I would have missed out on the best opportunity I’ve ever had to make a quick buck.
A lot of young investors fear putting money into the market because they fear losing it. It is easy to understand this fear. You are young, fresh out of college, and don’t want to risk losing what little money you are making.
Yes, the market is going to experience downturns, and yes your investment account will fluctuate with time. But history has proven that over the long run the market will continue to move higher.
Instead of fearing the possibility of down markets, use them as a buying opportunity to jump into new positions while stocks are cheap.
So to answer the question of when to start saving for retirement, the answer should be yesterday. If you haven’t already started saving for retirement, do it as soon as possible. Don’t invest more than you can afford, but it is important to put some money to work for your future.
Perhaps you can only afford $50 or $100 a month for now. That is OK. Over time, that money will grow nicely, and you will not look back with regret wishing you had started earlier.
It is never too soon, and your monthly investment is never too small, to start saving for a more comfortable retirement.