One of the worst pieces of advice that you can receive, or give to another person, is “saving for retirement can wait until you are older.” When I hear that phrase, it makes my skin crawl. Compound interest requires time to work its magic, and waiting kills most of its power. One crazy statistic that proves this is that Warren Buffett earned 99% of his wealth after his 50th birthday.
Let’s look at some compound interest math to show why this is terrible advice. We’ll deal with four different scenarios. In each scenario, the person graduates college at age 22 and starts a job making $40,000 per year. They all receive a 3% raise every year and a 3% 401k match from their employer. The differences between the examples is in how much they contribute to their 401k and when they start contributing. Each person will also earn an 8% return on their portfolio over the course of their investing time frame. Remember, this is just an example with made up people.
We’ll start with Ulysses the underachiever. Ulysses listened to some coworkers who said, “you’re young, worry about saving for retirement when you’re older and making more money.” Then when Ulysses turned 35, he read an article on personal finance and realized he should start contributing to his 401k, so he set his contribution to 3% and contributed until he retired at age 65. Unfortunately Ulysses missed out on the employer match from age 22 through 34, and missed out on the related compound interest. His 401k balance at age 65 would be about $590,000.
Next, we’ll take a look at Sarah who set her 401k contribution and forgot about it. Sarah’s parents told her to make sure to get the employer match at work when she started her first job. She started contributing 3% right away. She did that for the rest of career. When she retired at 65, she looked at her 401k statement and had almost $1,250,000. Not bad for setting it and forgetting it.
Third, we’ll take a look at Frank who, like Ulysses, did not think about saving for retirement until age 35. Like Ulysses, he began contributing to his 401k at age 35, with the difference being he checked the box on his 401k provider website that said “increase contribution by 1% each year, until contribution limit reaches 10%.” At 65, Frank had about $1,450,000 in his 401k.
Finally, we’ll end with Olivia the overachiever. She took a personal finance class as part of her business degree curriculum in college. She knew saving for retirement was important. At 22, when she received her 401k paperwork at work, she elected to contribute 3% right away and selected the box that said “increase contribution by 1% each year, until contribution limit reaches 10%.” Therefore from age 29 through 65, she contributed 10% of her gross pay to her 401k. When she retired at 65, she had over $2,400,000(!!!) in her 401k.
Albert Einsten once said “compound interest is the 8th wonder of the world.” Taking the time to put some effort and save for retirement in your early 20s can have a huge impact on your financial future. Don’t let time and compound interest pass you by.