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Time is the greatest tool we have for building wealth.
If two people save $100 a month for retirement, but one starts at 25 and the other at 35, the early saver will have nearly twice as much by age 65.
Starting to save now, wherever you are in your timeline, is better than starting tomorrow or next week.
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In personal finance, time is more than a four-letter word; it's the simplest and most reliable tool we have for building wealth.
It may sound premature to squirrel away money for retirement in your 20s (or even earlier) — hey, it's decades away — but a few years could make a difference of tens of thousands of dollars, or more, thanks to compound interest.
Compound interest is a form of exponential growth that rewards savers and investors, particularly those who act early. It's the snowball effect: As you roll a snowball down a hill, it gathers more snow. Not only does the original snowball grow in size, but each additional pack also grows.
Consider the following example and the chart below. Chris and Jennifer both invest $100 a month at a 5% annual compound rate of return. Chris begins investing at age 25, putting away $100 every month until 65 and Jennifer begins saving $100 a month at age 35.
An extra 10 years of saving means that Chris has about $162,000 in his retirement plan, while Jennifer has $89,000 by the time she is 65. Chris's balance is nearly double Jennifer's, and he contributed only $12,000 more of his own money.
Business Insider/Andy Kiersz
Now, if Chris and Jennifer incrementally increase their monthly contribution as they grow older — perhaps bumping up their savings rate by a small percentage with every pay raise — they'll wind up with even more money in that account at retirement.
Plus, investing in the stock market, whether directly or through a retirement account such as a 401(k), may yield a rate of return that's even higher than 5% in some years. Historically, the stock market's average rate of return has been about 7%, adjusting for inflation.
Saving in a tax-advantaged retirement account, such as an IRAor 401(k), can give your money an even greater boost. Those types of accounts are funded with pretax money, so your full dollar will have the opportunity to compound.
Time is a common element in the portfolios of many successful savers. TD Ameritrade asked 1,500 Americans with investable assets of at least $250,000 about their saving strategies. About 20% of this group are "supersavers" who save or invest an average of 29% of their income, while everyone else saves an average of just 6%.More than half (54%) of supersavers who invest started before age 30, the survey found, while only 40% of others did the same.
Hope isn't lost if you missed the boat in your 20s. Starting to save now, wherever you are in your timeline, is better than starting tomorrow or next week. It takes great patience to build wealth and there's no replacement for lost time.
This article was originally published in April 2019.
Tanza Loudenback
Tanza is a CFP® professional and former correspondent for Personal Finance Insider. She broke down personal finance news and wrote about taxes, investing, retirement, wealth building, and debt management. She helmed a biweekly newsletter and a column answering reader questions about money.Tanza is the author of two ebooks, A Guide to Financial Planners and "The One-Month Plan to Master your Money."In 2020, Tanza was the editorial lead on Master Your Money, a yearlong original series providing financial tools, advice, and inspiration to millennials.Tanza joined Business Insider in June 2015 and is an alumna of Elon University, where she studied journalism and Italian. She is based in Los Angeles.
If you're age 25 and have 40 years to save until retirement, depositing $100 a month into a savings account earning the current average U.S. interest rate of 0.42% APY would get you to just $52,367 in retirement savings — not great.
Investing $100 per month, with an average return rate of 10%, will yield $200,000 after 30 years. Due to compound interest, your investment will yield $535,000 after 40 years. These numbers can grow exponentially with an extra $100. If you make a monthly investment of $200, your 30-year yield will be close to $400,000.
Historically, the average annual rate of return for the S&P 500 has been around 10%. But even with an annual return of 6%, a 25-year-old making $100 monthly contributions would have just over $200,000 by 65 — double what they'd have if they had started making contributions at 35.
In fact, if you invest $100 a month over 40 years, you could end up with a portfolio worth $531,000. However, that number hinges on a very big assumption, and it's that your portfolio is generating an average yearly 10% return. But achieving that 10% may be more doable than you'd think.
You plan to invest $100 per month for five years and expect a 10% return. In this case, you would contribute $6,000 over your investment timeline. At the end of the term, SmartAsset's investment calculator shows that your portfolio would be worth nearly $8,000.
In year three you would save $540 a month and so on. Twenty bucks a month can't be worth that much, right? In this scenario, assuming the same 7% annual return, your ending balance after 30 years would jump from a little more than $606,000 to more than $867,000. That $20 a month would be worth more than $260,000!
Investing just $100 a month over a period of years can be a lucrative strategy to grow your wealth over time. Doing so allows for the benefit of compounding returns, where gains build off of previous gains.
“By the time you hit 33 years old, you should have $100,000 saved somewhere,” he said, urging viewers that they can accomplish this goal. “Save 20 percent of your paycheck and let the market grow at 5% to 7% per year,” O'Leary said in the video.
Ideally, you'd start saving in your 20s, when you first leave school and begin earning paychecks. That's because the sooner you begin saving, the more time your money has to grow. Each year's gains can generate their own gains the next year - a powerful wealth-building phenomenon known as compounding.
In simplest terms, take a $2,500 mortgage payment out of the picture and you've just reduced your annual expenses by $30,000. Now, factor that against the amount of money you'll need to manage retirement: between 55% to 80% of your current annual income, according to Fidelity.
One example is the $1,000/month rule. Created by Wes Moss, a Certified Financial Planner, this strategy helps individuals visualize how much savings they should have in retirement. According to Moss, you should plan to have $240,000 saved for every $1,000 of disposable income in retirement.
Everyone isn't going to want to spend $10,000 net a month in retirement. For some people, that will be way more than they need each month. For others, it might not be enough. And there might be some people that spending $10,000 net a month in retirement is just right.
Many retirement planners suggest using a more modest annual return of 6% when forecasting the long-term performance of a portfolio. At 6%, after 20 years the $200-a-month portfolio would be worth $93,070. After 40 years earning the same return, your model portfolio would be up to about $398,000.
“With a nest egg of $100,000, that would only cover two years of expenses without considering any additional income sources like Social Security,” Ross explained. “So, while it's not impossible, it would likely require a very frugal lifestyle and additional income streams to be comfortable.”
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