The power of time and compounding interest
In previous articles, we have discussed the importance of saving early in your career. Let's spend some time on this issue to understand its importance.
Although investment returns rarely are consistent year by year, we can make assumptions based on annualized returns over a period of many years.
A balanced portfolio of 60% stocks and 40% bonds has provided an annualized return of 6-10% in general over the last 70 years-depending on the 10 year plus time period in question. Let's take an annualized return of about 7% a year as your outcome on early savings.
There is the rule of 72, which approximates the number of years to double your money at any given interest rate. So, if we are taking a long term annualized rate of return of 7%, it would take about 10 years to double our money.
So, one dollar deposited on year one of your savings would double every 10 years. If you start at 25, that dollar would become 16 dollars when you turned 65 (assuming no taxes, such that it was put into an IRA or retirement plan). Proportionally, $10,000 would become $160,000!
Money deposited in year two would be very marginally less, but would be expect to total the same at age 66. On and on this goes.
Conversely, if you start saving just 10 years before retirement, your money will have grown at a doubling rate instead of 16 fold. Truly, your money is doing a great deal of work for you by just leaving it invested.
How much money you have for retirement is very closely correlated with how much you save annually and for how long you have saved. How much you earn on the investments themselves is rarely a major factor (assuming you don't make severe investing mistakes).
Saving early also has the benefit of keeping your lifestyle expenses lower than if you spend most of your income. This too is a powerful way to have a financially successful retirement.
If you are used to spending 95% of your income, you will have to have much more saved to provide this lifestyle from savings. Conversely, if you have learned to live on 75% of your income, your goals will be much easier to reach.
Steven Podnos, MD, CFP, is the principal of Wealth Care, LLC in Merritt Island, Florida. Send your financial questions to email@example.com.