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Yet Another Reason to Start Saving for Retirement Early

November 24th, 2008 · 17 Comments

Written by J.P. Wicklein

     Set up your retirement plan as soon as possible and regularly contribute to it.  The more you save toward retirement while you are in your 20’s, the more savings you will ultimately amass.  Should you be forced to stop saving for retirement in the middle of your career, saving at the beginning of your career could be your saving grace. 

Time is on your side    

     The sooner you start saving for retirement the better.  For example, if you save $10,000 per year right out of college (age 22) you will wind up with $1,000,000 (accounting for asset class diversification and inflation) by age 62.  Wait eight more years to start saving and you will only accumulate $610,000.  Drag your feet until age 40 and you will amass a paltry $325,000.

Life Happens

     Consider this:  If you started contributing $10,000 a year at age 22 and stopped at age 38 you would wind up with $610,000 by age 62.  (Don’t forget that even though you stop contributing at age 38 your money will continue to grow).  Why would you want to stop contributing in the first place?  You wouldn’t necessarily want to stop contributing.  Sometimes events occur that may force your hand.  What if you lose your job and take a new one at a significant pay cut?  What if your mom gets seriously ill and you have to quit your job to care for her full time.  What if your spouse wants to quit their job and raise the kids?  What if you get divorced and have to pay child support?  Any of these events and a myriad of other situations could impact you financially. 

     You will note that if you stop contributing at age 38 you will finish with the same amount of money as you would had you started at age 30 and never stopped.  You can save for 16 years (age 22) or 32 years (age 30) and still finish with $610,000.  This example further demonstrates the power of starting to save earlier rather than later.

     That said, if a life event were to hit at age 38 and you were no longer able to contribute to retirement it would stop your retirement savings regardless of whether or not you started saving at age 22 or age 30.  With a life event hitting at age 38, you will still amass $610,000 (assuming you started saving at age 22).  If you started at age 30, however, you will wind up with about 2.5 times less money, $240,000. 

     The next time you sit down to decide whether or not you should start saving for retirement remember that the sooner you start the more you’ll have.  This is even more important to remember should a life event cause you to stop saving for retirement in the middle of your career. 

Tags: Retirement

17 responses so far ↓

  • 1 Larry // Nov 24, 2008 at 9:29 pm

    I gotta think that anyone that doesn’t start contributing to their retirement account (401k or otherwise) from day 1 is crazy.

  • 2 B. Estey // Nov 25, 2008 at 12:57 pm

    I agree with you Larry, but remember that not everyone has the luxury of saving or enough understanding of a buck to know how to save. It seems simple but I have clients that are truly not capable of saving money unless someone forces them to put it where they can’t get it.

    Saving is a learned activity. If it wasn’t instilled in you by someone along the way it won’t necessarily come naturally.

  • 3 James Baxter // Nov 25, 2008 at 6:24 pm

    I wonder what the percentage is of able people in northamerica who can make an extra 10k a year at age 22.

    Well, drug dealers aside I bet (sadly) that percentage does not even make a blip on the map.

    -Jim
    “I rarely pays to play fair.”

  • 4 Andy @ Retire at 40 // Nov 26, 2008 at 3:02 am

    Those graphs really visualise how it all works out. It’s amazing when you think about it and I wish someone had showed me these pretty pictures when I was 22. As it is, I’m just glad I’ve started now at 32 rather than at 42!

  • 5 Jasper // Nov 26, 2008 at 11:20 am

    To the person who believes Americans don’t have an “extra” $10,000…
    #1 I’ll bet the author was only using that figure as a nice round number with which to illustrate a point, i.e. what happens to growing money over time; saving was the message, not saving $10k.
    #2 Yes, they would have an extra $10k if they didn’t spend so much. The Chinese people save up to 40% of their earnings. Americans spend it all and then ask for credit for more, and they’ve been doing so for years. Wake up, America!!!

  • 6 Jasper // Nov 26, 2008 at 11:28 am

    Special shout out to Andy! I started at 32 also, though I have now turned 33! Keep up the investing! This crisis WILL end. There have been doomsayers since the beginning of time, but IMHO as long as the population is growing, so will the economy, eventually. We have time to wait, and in 30 years there will be many BILLIONS more people than there are today, barring a worldwide epidemic or the like, in which case I will be very glad I started saving as early as possible, because it is those billions in poverty who will die first, because they have to go to work and expose themselves to other people who have to go to work & cannot afford to take a sick day.

  • 7 Jasper // Nov 26, 2008 at 11:31 am

    CORRECTION: Excuse me, but I feel stupid for writing “worldwide epidemic” because there is a word for that, and it is “pandemic”…

  • 8 Financial Fellow // Nov 26, 2008 at 10:34 pm

    @ Jim - Thanks for your comment. To Jasper’s point I was just picking $10,000 as a nice, round number to use as an example. Admittedly for many people it could be hard to come up with an extra $10,000 a year. That said, if folks were to prioritize retirement savings that amount becomes much more attainable.

    @ Jasper - I agree with you wholeheartedly. Americans spend too much damn money. Our national savings rate is pretty much 0%. Americans need to feel a little pain in this recession in order to provoke them to save more money.

    @ Jasper & Andy: Great to hear that the two of you are saving for retirement. It’s never too late to start and even in your early 30’s you are still well ahead of the pack and you will also still have a very long time to compound your returns. Nice work.

    John

  • 9 Tim B. // Nov 30, 2008 at 3:58 pm

    Just wanted to comment about the graphs. It appears that are several assumptions being made. One is that you will get a consistent rate of return. However, younger savers will have the bulk of their portfolio in stocks. It is as evident today as it would ever how volatile the market is, and it sort of depends where your starting point is.

    For example, those who dollar cost averaged into the market during the seventies had two bull market decades that followed. Those who started to invest in the mid to late nineties had two major bear markets ahead of them. In addition, the market can remain undervalued or overvalued for long periods of time (I realize this is contradictory to efficient market theory).

    I understand that their allocation changes as they age, but I just wanted to point out that the starting point AND ending point matters. Say someone who was ready to retire in 2008 and had half there money in bonds and half in stocks still would have gotten beat up. I understand, though, that the moment they retire they don’t pull all of their money out.

    One other assumption is that the investor is a “rational economic man” as behavioral finance dudes would call them. A “behaviorally biased man” and advisor may not always have the appropriate allocation for the investor.

    However, I’m all in favor for people to start saving early. In fact, I’m trying to get my 19 year old brother in the market.

    I apologize for rambling on.

  • 10 Financial Fellow // Nov 30, 2008 at 6:22 pm

    Tim -

    Thanks for your comments. You’re right, there are several assumptions being made with the graphs. To put them all in the article would way it down with details and take away from the main point….which you summed up well by stating that you’re in favor of people that start saving early.
    To answer some questions regarding assumptions surrounding the graphs.
    1) I’m not actually assuming a constant rate of return in the graphs. Rather, I’m assuming a portfolio of mostly stocks at the younger end that gradually shifts to a portfolio of mostly cash and bonds by age 65. So, the assumed annual rate of return at age 22, for example, is much higher than the assumed rate of return at age 65. Had I assumed a constant rate of return the graphs would have actually had an even steeper exponential curve.
    2) Here’s the other kicker: I shaved off 3% off the annual return to cover inflation. So, the $610K that I refer to at the age of 62 is actually in today’s dollars.

    Good point on the decades in which you save. I think the behavioral biases can large be removed through investing exclusively in index funds through dollar cost averaging… But that’s a whole other discussion.

    I’ve always felt that you can slice the whole retirement saving thing in a thousand directions: What percent of your portofolio is in stocks/bonds/cash, do you do index or actively managed funds, traditional vs roth, dollar cost averaging vs. market timing, etc, etc…

    The bottom line, though, which you captured in your final comment was that saving for retirement is important and starting early is key. I’m of the opinion that starting early and contributing regularly is more than half the battle. The next steps (asset class allocation, passive vs. active, traditional vs. roth, etc…) won’t have as large an impact if you start later in life.

    Thanks again for the great insights.

    John

  • 11 SusieQ // Dec 3, 2008 at 7:56 pm

    I was fortunate enough to start my 401k at 21 (the earliest age possible with my company). Unfortunately, it took me working for an entire year without saving a NICKEL to realize my mistake–what an epiphany! I had nothing but a year’s worth of partying to show for all of those early mornings in the office. I’m glad I had my wake up call early in my career…

  • 12 Financial Fellow // Dec 3, 2008 at 8:05 pm

    I don’t know if I’d call a full year’s worth of partying a waste of time. ; )

    But you’re right. Starting in your early twenties is great! I’m sure you are way ahead of your peers. I started my 401k at 22. I started contributing to a Roth IRA at 26. I should have started sooner but I figure that’s still pretty good. It’s never too late to start saving!

    Thanks for your comments, Susie!

    John

  • 13 Simon // Dec 30, 2008 at 10:21 pm

    This is very true, and a great article. I really wish they would teach this stuff in grade 11 and 12 so that when kids get into the work force they start this immediately… and understand the long term power of it. I was lucky and learned about ‘dollar cost averaging’ in a retirement program at age 21. Even all these years later becoming an investor and trader in the market, I STILL contribute to that program every single month. I just move the money around alot more now that I know what I’m doing.

  • 14 jetmacjoe // Dec 31, 2008 at 3:49 pm

    Does anyone know a 22 year old that can put
    $10,000 a year away?? When I was 24 I only made $14,000 (before taxes!!) in my last year in the military. This was only 20 years ago. But the
    point of the illustration is correct and well taken.

  • 15 Financial Fellow // Jan 1, 2009 at 8:54 pm

    Jetmacjoe -

    You’re right - you’d have to have pretty fortunate circumstances to be able to sock away that much money in your early 20’s. Either earn a hefty salary and live frugally or live with your parents rent free.

    Thanks for your comments!

    John

  • 16 kenneth // Jan 2, 2009 at 4:14 pm

    sadly 90-95%+ of the 20 year olds can forget about retiring. in addition folks always take into account the value of the dollar when trying to forecast how much you will have in the future. if your rate of return is 4% yearly and the dollar is losing value at a rate of 5% per year, you are drowning.

  • 17 Financial Fellow // Jan 4, 2009 at 2:38 pm

    Kenneth -

    I agree, the value of the dollar is a consideration. I don’t think that the impact of the dollar may be that pronounced, though, if you diversify by investing in foreign stocks. Any long term decline in the value of the dollar can be mitigated having some of your gains be in foreign currencies that gain against the dollar.

    You touch on another topic of interest, though. The decline of the dollar. I agree with your sentiments that he dollar is on a long decline. Thanks for the insight!

    John

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