You’ve probably heard hundreds of times to “start saving for retirement now.” Yeah, yeah. You get it. You should save money for retirement. But how seriously are you taking this advice? Do you really understand why people are so insistent about this?
A fundamental concept in personal finance is time value of money. Before you skim over this part, give me a minute to explain. Time value of money is the idea that money today is worth more than money at any time in the future. This is because money you receive today can be invested and gain value, whereas money received in the future does not have that opportunity.
Let’s put this into perspective. Assume four friends start to save for retirement at different ages. Sam begins to save $300 a month starting at age 25. Charlie begins to save $300 a month starting at age 26, Alex $300 a month at 30, and Erica $600 a month at 40.
Assuming a conservative annual rate of return at 5%, the friends savings grow as depicted in the below chart.
By the age 70:
Sam had contributed $162,300 that grew to $611,000 of savings, 276% growth.
Charlie had contributed $158,700 that grew to $578,000 of savings, 264% growth.
Alex had contributed $144,300 that grew to $460,000 of savings, 219% growth.
Erica contributed $216,600 that grew to $502,000 of savings, 132% growth.
The biggest takeaways are that Sam started saving just one year before Charlie and ended up with approximately $33,000 more in savings, by only contributing an additional $3,600. Pause for a minute and consider all of the ways you could spend $33,000.
Additionally, you should note that Erica contributed almost $55,000 more than Sam but ended up with $110,000 less in savings because she waited so long to begin saving for retirement.
Regardless of how you read this data, I hope you can see that the more you save now, regardless of amount, the greater the opportunity your money has to grow. This is why it is so important to start saving money as soon as possible.
