Saving For Retirement– In Your 20s (Part 1)

saving retirement Even if you’re just starting out in your career, saving for retirement should be one of your top financial goals in life.  You might find it difficult to rationalize saving for an event that’s a good forty to fifty years out.  You might say to yourself, “No worries.  I’m still young.  I’m still in my 20s.  I have the rest of my life to save for retirement.”  It’s easy to put off saving for something that’s not going to happen until decades down the road.  There are a lot of things that you have to deal with right now, so naturally, retirement is just an afterthought. 

Well, that’s just it.  If you’re in your 20s, retirement is forty to fifty years away.  That’s forty to fifty years for you to save.  That’s forty to fifty years for the power of compound interest to work its magic. The best time to start saving for retirement is NOW. The earlier you start, the more money you will have for your golden years.  The best thing you have on your side is time. Don’t squander that advantage.  Let time work for you, not against you. You’re just going to make it that much easier for yourself if you start now.
Another advantage you get from starting out early is giving you more options when you actually do retire. There are so many vehicles to invest in your 401k and IRA’s, which include stocks, bonds and even gold and silver. If you do decide to add precious metals to your retirement fund, its critical to do your due diligence and research gold IRA reviews which will help you choose the right company to work with. This will insure you will avoid any scams and get the best price and service for your investment.

The Power of Compound Interest

In order to highlight the importance of time, we’ll need to understand the difference between simple interest and compound interest.  Simple interest is just principal xrate of interest x time.  It ignores the effect of compounding.  You take your principal, figure out what your rate of interest is, multiply the two, and then multiply that by a specified number of time periods.  Compound interest, on the other hand, does take into account the effect of compounding.  Not only are you deriving a rate of interest from your principal, but you are also deriving interest from your interest.  To better illustrate the difference between the two, let’s look at the following example:

John has $5,000 in a brokerage account.  He expects to earn a 5% annual rate of interest.  In five years, the simple interest from his account will be $1,250 ($5,000 principal x 5% rate of interest x 5 years).  That gives John a total of $6,250 in his account at the end of five years ($5,000 initial principal + $1,250 interest) .  Simple interest is just a quick and “simple” way of calculating interest.  In reality, John’s interest in his account will be compounded.  In five years, if John’s interest is compounded annually, he will actually have $6,381.41.  He has gained $1,381.41 in interest, thanks to the power of compounding.  Why the difference?  After the first year, John has $5,250 in his account ($5,000 principal + $250 in interest).  Whereas simple interest assumes that John will just have $250 in interest again in his second year, compound interest takes the new total at the end of the first year ($5,250) and applies the 5% rate of interest to that new total.  Thus John actually gains $262.50 ($5,250 x 5%) in his second year.  That sets up an even higher new total to work with in the third year ($5,512.50), and so forth.

The Numbers Are Staggering

As you can see, over time, the totals will continue to increase.  The more time you have to work with, the more interest you will gain.  That’s why it’s not inconceivable that over forty to fifty years you will actually have more in interest than in principal.  The power of compounding is more astounding when dealing with a longer period of time.At a 7% expected annual interest rate, a 25-year-old individual will need to contribute $5,009.14 each year to reach $1,000,000 at the age of 65.  If that 25-year-old individual decides to wait 10 years and does not start saving for retirement until age 35, the annual contribution required increases to $10,586.40.    By delaying retirement saving 10 years, this individual will now have to fork out more than double the original amount (by starting at age 25) each year.  Let’s look at this from another angle.  At the same 7% expected annual rate of return, if the 25-year-old individual contributes $6,000 each year until she is 70 years old, she is looking at a grand total of just over $1.7M.  If that same individual does not start saving $6,000 each year for retirement until the age of 35, her grand total at age 70 is $829,421.27.  Holding off yet another 10 years (at 45 years of age) will only net her $379,494.23.  The numbers just continue to decrease exponentially.  In the previous example, if that individual were to start saving at the age of 25, almost $1.5M of her nest egg would have been attributable to interest.  Her principal over the 45 years only comprised about 15% of the final total.  Therein lies the power of compound interest.  In part two of this article, I will explore the various types of accounts to store your retirement contributions.  The major takeaway from this post is that the best time to start saving for retirement is NOW.  You have to let compound interest start working its magic now.  Each year you hold off, the opportunity costs skyrocket.  That’s why it is imperative to get a jump on saving for your retirement as soon as possible.