Saving for retirement can be difficult to prioritize.
Many of the decisions made with your finances today can have a large impact on your money as you near retirement age. That can make for difficult choices when prioritizing how to use your hard-earned money.
But, in reality, the best time to save for your retirement is now. By choosing to save and invest early in your career, you are planting a seed and giving it plenty of time to grow and contribute to better financial security in retirement.
When saving for retirement, time is important. Use it to your advantage by saving early. In our past video on maximizing retirement savings, we give a visual overview of reasons why now is the time to start.
Let’s look at this idea by examining the changing cost of milk over time. The costs are:
1968: $1.07 would buy you a gallon of milk
2018: That same $1.07 would only buy you a 1/3 of a gallon of milk
Over time, inflation is constantly eroding the purchasing power of a dollar.
That is why inflation hurts us when we delay saving for later: Our money is literally worth less than it was before.
And that’s why compound interest is a powerful way to fight inflation. When you save money, you earn interest on what you saved. That interest is added to what you saved, which means you also get to earn interest on that interest. Simple interest, on the other hand, is when you earn an interest rate only on your initial investment.
Because compound interest reinvests your past interest earned with your principal, it is often referred to as “earning interest on interest, which can lead wealth to rapidly snowball.”
Here’s what this means in terms of money:
- Jane and Joe are the same age and earn the same amount.
- Jane invests $3,000 a year from age 30-39, which means she put $30,000 into her 401(k) over 10 years.
- Joe invests $3,000 a year from age 40-65, which means he put a total of $78,000 in his 401(k) over 25 years.
- When Jane retires, she has $321,443. Joe has $259,052.
Joe put in $48,000 more than Jane and walked away with $62,391 less. (We assumed both earned a hypothetical 8% average annual return.)
How can Jane’s 401(k) have $62,391 more than Joe’s at age 65 even though he contributed $48,000 more? There were not differences in returns — we assumed a hypothetical 8% average annual return for both of their portfolios. The answer simple: It’s time.
This is the power of compound interest over time. Even the $3,000 per year that Joe added until age 65 could not make up for the 10-year delay in starting.
Imagine a snowball — an investment snowball that is your retirement savings.
If you let go of your “investment snowball” near the peak of a mountain, it gets bigger and faster as it rolls down the mountain.
The bigger it gets and the faster it rolls, the more momentum will build, allowing your “investment snowball” to move faster and grow by giving it the opportunity to pick up more snow on the way down. At the bottom, the “investment snowball” is likely much larger than when it started.
If you delay investing until later in life, it would be like only rolling your snowball halfway down the mountain.
It’s won’t get nearly as big or roll as fast.
With all the opportunities to spend your earnings on more immediate experiences and expenses, it can be easy to delay making that first investment or committing to saving. Although challenges arise when deciding how to allocate your money, putting money aside for retirement is paying your future self.
Some experts say you’ll need to have saved at least $1 million to retire. With that number growing each year, it makes sense to start to save as early as you can so your hard-earned money gets an earlier chance to grow.
Ready to start planning your financial future?