The Time Value of Money and Why Saving for Retirement Early Makes a Difference
In investing, and in life, the greatest power we have is time.
Learning how to invest at an early age is secondary to understanding why. Though it can be tempting to spend what you have now, saving for retirement can pay off tremendously in the long run.
Compound interest happens when an initial deposit builds on itself over time using interest. Compound interest is positively correlated with time, which means the longer an account balance accrues, the bigger the payoff will be in the end. When interest is compounded multiple times throughout the year, the quicker the account balance grows.
Compound interest accrues on investment accounts, savings accounts, some checking accounts and certificates of deposit (CDs). It also accrues on debts like student loans, mortgages and credit cards, so the formula can work against you in other scenarios.
When it comes to your investments, even small, regular contributions in your 20s can go a long way.
An example of the compounding growth of investments is a simple investment started at age 25. A 25-year-old could start saving $880 a month, earning 5% interest, and at the age of 60, could be a millionaire.
However, that same individual, should they wait ten years and start saving at age 35, would have to accumulate $1,697, a difference of $799 a month, just because they waited ten years to start investing.
Is that amount too much to imagine? A $1,000 deposit, compounded annually at 5% interest, would grow to $4,321.94 in 30 years without ever having to add another deposit.
The power of investing early is so strong, yet many Americans fail to do it because we make choices about living in today instead of saving for tomorrow.
Employer-Sponsored Retirement Plans
And here’s the how: an employer-sponsored retirement plan.
Less than 30 percent of workers aged 25 and younger participate in their employer’s 401(k) plan. Most employers offer matching contributions. Choosing not to participate in one of these plans is like saying no to free money! And when deductions are automatically withdrawn pre-tax from your paycheck, it’s hard to notice the missing amount on a regular basis.
401(k) contributions max out at $20,500 per year in 2022. Contributions to a traditional 401(k) are made with pre-tax dollars, so you’ll also get the benefit of lower taxable income.
The bottom line: start saving now. The longer you wait, the more you’ll need to save each month to catch up.
There are simple calculations to use based on your age and income that show how much you need to save to meet certain goals in life. A qualified financial advisor can walk you through these calculations according to your income, age and specific goals in life.
If you would like to learn more about the time value of money investment strategies and how to create your own wealth management plan, reach out to Adams Brown Wealth Consultants.