Let’s say you didn’t start saving for retirement then. What happens next? A year or two later, you’re due for a raise, and where does it go? To a nicer apartment, or a nicer car. The next raise goes toward your wedding or a down payment for a new house, and so on.
As you can see, it’s so easy to keep postponing saving for retirement. But what we’re about to show you next will blow your mind: Waiting to contribute when you make more money doesn’t make any financial sense.
Why You Can’t Make Up for Lost Time
Let’s say you’re 25 and you want to have $1 million when you retire 40 years from now. If, over time, the market returns, on average, 7% a year, you’ll only need to save about $5,009 a year—$200,360 total—to get to your goal. You make $35,000 a year, so setting aside about $5,000 a year (more than $400 a month) sounds impossible, and you’re probably tempted to delay saving for retirement until you start making more money.
But think about this: Contributing $5,009 a year right now will leave you about $30,000 a year to live on. But if you wait until you’re 45 and making more money—let’s say, $60,000 a year—and start contributing then, you’ll have to contribute $24,393 a year to get to your retirement goal of $1 million! And that leaves you $35,607 a year to live on—at age 45.
But if you had started at 25, you would still be contributing just $5,009 a year at age 45, so you would have almost $55,000 a year to live on—not bad.
So now, when would you like to scrimp? When you’re young, all your friends are in the same boat and you have almost no responsibilities? Or when you’re 45, have two children and are dreaming of a beach house? (And if you’re already 45, then start now, rather than at 55!)
Why Time Is So Crucial to Growing Your Retirement Savings
As you can see, starting early makes saving for retirement a lot easier. Why is that? Take Charles and Katie. Both of them put $24,000 into their retirement accounts over the years, but Charles began saving ($50 per month) at age 25, while Katie began saving ($100 per month) at age 45.
Even though they both put in the same total amount, Charles will have almost twice as much money at retirement as Katie will when they reach age 65. Why? His money had more time to grow, so it was able to accumulate much more than Katie’s money.
The reason time gives such a big boost is because of something called compounding. For instance, let’s say someone invests $2,000, and the investment grows 7% a year. After one year, they’ll earn $140. The next year, they’ll earn $149.80. The almost $10 extra comes from the fact that the $140 they earned the year before will itself also earn 7%.
RELATED: Compound Interest 101: How It Works
After 10 years, assuming that the investment grows at exactly the same rate every year (it doesn’t happen like that in real life, but usually does on average over time), that $2,000 will have grown to $3,934.30. In 20 years, it will be $7,739.37—not because any money has been added, but simply because the money has had more time to grow.