Starting Early

For the past few weeks in my personal financial planning class we have been discussing retirement planning. One of the things I like most about teaching this topic to college students is that I can provide some encouragement to a demographic that often feels overwhelmed, behind, and simply stressed.

It may seem like talking about retirement to a group of young people barely in their 20’s might not be the most engaging conversation, and it often isn’t. However, once the students see the difference time can make their interest is piqued.

When should I Start Planning for Retirement?

One of the key determinants of a successful retirement plan is the length of time to execute. There is a dramatic difference between starting to save for retirement when you are 25, and waiting to start when you are in your 40’s.

Earlier is Better

Take two scenarios. In both, the individual is saving $400 per month in a retirement account and earning an average annual return of 8% and wants to retire when they are 65 years old. Consider that one of the individuals is 25 and the other is 45. What is the difference in total retirement savings when each person reaches 65? It should be clear to you that the person who started when they were 25 years old will have more savings. (If not, stop reading this blog. There is nothing I can do to help you. (Just kidding, come immediately to my office, we have a lot to talk about.)) But how much more?

The 45-year-old will have approximately $235,608.17 in their retirement account. The 25-year-old? $1,396,403.13. That is a difference of $1,160,794.96.


Where did that difference come from? The 25-year-old saved for 20 more years than the 45-year-old. That is only a difference of $400 per month X 12 months per year = $4,800 per year x 20 years =$96,000. This means the 25-year-old retirement saver only contributed $96,000 more than the 45-year-old.

Compounding Interest

The answer is compounding. By starting 20 years sooner, the retirement savings has more time to earn a return. Going back to those original assumptions, the first $400 saved had 40 years to grow at an annual rate of 8%. That means that the first $400 contributed to an IRA or 401k is now worth $9,709.35. The second $400 is now worth $9,645.05. You get the point. As the cliché goes, time is money.

The reality is, most people don’t start saving for retirement until they are much older than 25. That waiting comes with a steep cost.

The 45-year-old can catch up though right? Sure. Let’s see how much the 45-year-old retirement saver would have to contribute each month to have that same $1,396,403.13 that the 25-year-old has? $2,370.72. Ouch. Think about your own salary, or salary you anticipate when you reach 45, and imagine siphoning $2,370.72 out of it to stash away into a retirement account each month.

This is only a simple illustration, and there were a lot of simplifying assumptions made. There is still a lot to talk about. For starters, we assumed a constant 8% return. Investment returns vary, sometimes significantly depending on the specific asset classes chosen and the degree of investment diversification.

Future Uncertainty

We also can’t know looking forward what the actual return of a given investment portfolio will be. Maybe it’s 16% or -4%. We can make some reasonable statistically based assessments based on investment selection and optimum portfolio construction, but ultimately, nothing is certain.

No adjustment was made for rising income levels as the saver aged. Maybe the saver starts out saving $200 per month but increases that amount as their income level rises.

There’s a term, ceteris paribus, we use in economics. It means that we are assuming everything is held constant except for the specific variable we are discussing. In this example, it means all these simplifying assumptions are the same for each scenario such that regardless of what the other conditions were or are, we know that starting early has a dramatic impact on the total amount of retirement savings.

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