“You’re in your early 20s. That’s too early to start thinking about retirement.” Wrong. So completely wrong. Now is the best time to think about retirement. Sure, it’s a long way off, but even a small percent of your salary can mean a nice bit of savings in the long run thanks to the power of compounding interest.
Start an IRA
I was inspired to write this post because ING/Sharebuilder is offering FREE automatic investments for the year when you start a new IRA with them before 15 Apr 2010. I already have a Roth IRA with them, but I decided to start another one. Those normal $4 commissions really add up and put a dent in returns, especially when saving as little as I am, and if I can get all of those transfers for free for a year, well, I’m gosh darn gonna try! The promotion applies to both Roth and Traditional IRAs as well as Rollover Roths.
If you’re not interested but are considering opening up a non-IRA account with them, leave a comment to that affect and I’ll pass along a referral that nets me five free investment trades and you $25 to invest.
Why?
As I said, compounding interest is amazing for growing money. I started my Roth IRA just a few months before my 23rd birthday. There’s not a lot of money in there, because I only put in $50/month right now while I pay off debt. At $4/trade, that’s a lot of fees in relation to the investment, so I started doing the investment every other month at $100 for now, until I can bump up my monthly contribution. But let’s run some numbers about what I’m gaining by even my paltry investment.
In my calculations I’m considering a really low return: 5%. Historically, smartly invested funds will net about 10% in the market over the time we’re talking about before retirement. At 5%, we should barely beat inflation. But, this requires investing in the market or things like bonds, not letting it sit in your local bank savings account or CD.
| Starting age | Monthly investment | Money invested | Interest earned | Total value at age 65 | Monthly to match age 23 | Increased investment | Interest earned |
|---|---|---|---|---|---|---|---|
| I’m rounding. Numbers aren’t precise, but close. | |||||||
| 23 | $50.00 | $25,200 | $60,724 | $85,500 | – | – | – |
| 33 | $50.00 | $19,200 | $28,236 | $47,436 | $ 90.00 | $34,560 | $50,940 |
| 43 | $50.00 | $13,200 | $10,867 | $24,067 | $178.00 | $46,992 | $38,508 |
| 53 | $50.00 | $ 7,200 | $ 2,679 | $ 9,879 | $433.00 | $62,352 | $23,148 |
I’m using simple math here. Compounding annually, ignoring inflation, conservative return, ignoring commissions.
What does this show us? By saving $50 a month in an investment vehicle that is only returning 5%, starting at age 23, you get over $60,000 interest on top of your principal. If you wait 10 years, starting at age 33, that free money shrinks to only a little over $28k. Meanwhile, if you plan to have $85,500 in the bank at 65 like you would had you started at 23, you’ll have to bump up your monthly contribution to $90, and you’re still losing out on $10k in interest. And that return shrinks exponentially the longer you wait.
If you don’t believe me, play around with this calculator. It’s simple, but simplicity at it’s best: it’s very clear about the differences between starting now and starting later, with nothing fancy to confuse the fact.
N.B. The savings I’m talking about here is on top of any employer-based retirement plan if one with matching is available. If you’re not already contributing enough to get the employer match if you have one, you’re doing things wrong. Obviously, saving $50/month for retirement isn’t going to secure you a nest egg. Even my full retirement savings, currently around 7.6% of my income including a 3% employer match won’t set me up for retirement. I know I have to step it up once I pay down debt. But based on these numbers, the money I’m saving now is miles beyond better than saving nothing, don’t you think? So, why not start now?
But, I’m in debt!
I argue that even being in debt is no excuse not to start saving. With a caveat: If you’re so in debt that you’re paying minimum balances, pause retirement savings. You need to set up a budget, forgo some luxuries and pay off debt so that you can start saving. But I’m not a financial adviser. If you really are struggling that much, you need to go see one.