“Someone is sitting in the shade today because someone planted a tree a long time ago.” – Warren Buffett
A great way to figure out how to plan ahead with your finances when you are younger is to ask someone older than you what they wish they would have done when they were younger (and investing in Apple stock in 2001 when it was under $8 a share doesn’t count).
The answer that I hear over and over again when I ask this question is, “I wish I would have started saving for retirement earlier.” They say the best time to start saving is 10 years ago, but the second best time is today.
Unfortunately, people will always have reasons to put it off for another day. Once you get out of school you will likely have to pay off student loan debt. You might get married and then have to save for a down payment on a house. If you have kids, it’s estimated that they will cost between $200,000 to $300,000 from when they’re born through age 18. It feels like you’ll never have the perfect opportunity to set aside money to begin planning ahead financially.
The best thing you can do to break this vicious cycle is turn saving into a habit and start young. As a young person you’ll make far less money than your elders, but you have an asset that they could only dream of – time.
Let’s take a look at an example to see why this is the case. Let’s assume Brian waits until he’s “ready” to save money at age 38. He decides to put aside $300 a month (increasing that amount by 3%/year to account for inflation) into his investment account and continues to do so until age 65, when he plans on retiring. Assuming an 8% annual rate of return on his investments, Brian would retire with around $458,000.
Next we have Anna who gets her finances in order ten years before Brian. She begins saving $200 a month (again with a 3% annual increase) into her investment account and continues to do so until age 65. Assuming an 8% annual rate of return on her investments, Anna would retire with almost $750,000.
Finally, we come to Gordon who puts aside $100 every month (with that 3% annual increase) starting at age 18. He also saves until age 65 and earns the same 8% per year on his funds. Because he started saving at such a young age, Gordon ends up with close to $870,000 at retirement.
Here is the summary for all three of our savers:
You can see that even though Gordon saved about half as much money as Brian in total, he still ended up with almost double the total amount when all was said and done. There are two simple reasons that Gordon has a higher ending balance than both Brian and Anna, even though he saved less money:
1. Time. Brian, Anna and Gordon saved money for 28, 38 and 48 years, respectively. Gordon gave his money more time to grow than the other two. In the investment world, time is more important than just about anything else.
2. Compound interest. The reason time matters so much when trying to grow your wealth is because compound interest takes time to marinate. When you earn money through growth (from higher profits) or income on your investments your bottom line increases. For example, earning 10% on $100 would give you $10 in investment gains. You now have $110 and if you were to earn another 10% on that you would now earn $11. Your earnings grow with each increase. Compound interests means you will see higher dollar returns on your money in the future as you begin earning interest on top of interest on top of interest…
This is why time is such a powerful asset for young people. Time allows you to save a relatively small amount of money at a young age and watch it grow on itself over time through the power of compound interest. Compound interest is like a tiny snowball that starts at the top of a hill and slowly works its way down over time, accumulating more and more snow along the way until it becomes a massive boulder by the end that works like a runaway freight train in your favor.
And the best part about saving money from an early age is that you develop the right saving habits that can allow you to save even more money in the future.
Ben Carlson is the Director of Institutional Asset Management at Ritholtz Wealth Management, and writes for “A Wealth of Common Sense,” a blog that focuses on wealth management, investments, financial markets and investor psychology. Find him at AWealthofCommonSense.com.