Benefits of Starting Early
Young people may think they are at a disadvantage when it comes to saving for retirement because they are still at the beginning of their careers and may have modest incomes. However, there are some distinctive advantages, especially if you start saving early.
The Power of Compounding
Saving early and regularly, even in small amounts, can lead to significant gains over the long term thanks to the power of compounding. Compounding is the process of earning interest on the interest from an investment. Here are two examples illustrating investment with and without compounding.
One-Time Investment for Retirement
Suppose you are 25 years old and invest $2000 for 35 years, with the investment earning 5% annually. In the first year, you will earn $100 (0.05 × 2000) in interest. By year 35, you will have earned $3500 (100 × 35) in interest for a total balance of $5500.
However, if you reinvest the $100 earned each year, you will also earn interest on that $100 as well. In other words, in the first year, you start with a $2000 investment, but by the beginning of the second year, you will invest $2100. By year 35, you will have earned $9032 in interest for a total balance of $11032. Thus, an additional $5532 is added thanks to compounding compared to the $3500 in interest without compounding.
Monthly Investment
If you are in your twenties and start saving early, you don’t have to invest a large sum of money upfront. Instead, you can choose to invest a smaller initial amount and contribute a portion of your paycheck each pay period. Let’s take a look at an example of a 25-year-old saving for retirement.
In the first year, you invest $500. Each year for 35 years, you earn 5% interest. Each month, you contribute $100 to your savings plan for a total of $1200 annually. By year 35, you will have contributed $42500. The total compound interest will be $68642. Your total balance will be $111142 in 35 years.
The key to building retirement wealth is to start saving early, even if you can’t save a large sum of money at first. Remember, you can increase your contribution amount later when you have a higher income due to pay raises or promotions.
You can also add an extra amount each year if you receive a tax refund. In short, use your youth to your advantage by allowing the power of compounding to work for you.
Starting Early vs. Starting Later
It may seem easier to delay saving for retirement until your income increases and you can contribute at that time. However, this strategy diminishes the power of compounding.
Delaying Retirement Savings
Let’s use the same example, but instead of starting at age 25, you start saving at age 35. Thus, there are only 25 years until retirement at age 60. In the first year, you invest $500. Each year for 25 years, you earn 5% interest. Each month, you contribute $100 to your savings plan for a total of $1200 annually. By year 25, you will have contributed $30500. The total compound interest will be $28466. Your total balance will be $58966 in 25 years.
By waiting ten years to save for retirement, your total retirement balance will be $52176 less than it would have been if you had started saving at age 25 ($111142 – $58966).
Catch Up
Saving
If you start saving for retirement later, at age 35, you can achieve the same total balance you would have achieved by starting at age 25, but you will need to increase your monthly contributions.
Assuming the same initial investment of $500 and an interest rate of 5%, you will need to contribute $191.10 monthly for 25 years to achieve a balance of $111,142 by age 60. In other words, you need to increase your monthly contributions by $91.10 to reach the same total balance you would have if you had invested $100 monthly starting at age 25.
By saving early, you allow compounding to do some of the heavy lifting when it comes to retirement savings.
Retirement Planning Strategies in Your 20s
Retirement planning will involve investing your money in different types of mutual funds, exchange-traded funds, or bonds. A fund is a basket of securities.
Source: https://www.thebalancemoney.com/best-retirement-strategies-for-your-20s-4177587
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