Monday, November 30, 2009

The Importance of Starting Young

A friend recently told me that his daughter, in her mid-20s, wasn't thinking much about saving or investing now, but thought this was something to start thinking about in 5 years or so.  This brought to mind the many illustrations I've seen about the importance of starting to save and invest as early in life as possible.  Starting just a few years earlier can have a dramatic impact on how much money one ends up with when they retire.

In The New Coffee House Investor, Bill Schultheis points out that the investor who starts saving and investing $300 monthly at age 25 instead of 35 invests only $36,000 more, but ends up with $604,195 more by age 65, assuming a 7% compound annual return in a tax-deferred account (e.g., 401K or IRA).

In The Investor's Manifesto: Preparing for Prosperity, Armageddon, and Everything in Between, William J. Bernstein puts it this way.  Each dollar that you don't save at 25 means two inflation adjusted dollars that you'll need to save if you start at age 35, four if you start at age 45, and eight if you start at 55.  Since a 25 year old should be saving at least 10 percent of her salary, this means that a 45 year old will need to save nearly half of her salary, which of course is likely to be impossible.

Another way to illustrate this that might make an impression is to show what happens if Jill starts saving $5000 per year in a tax deferred account at age 25, and stops contributing to the account at age 35, while Jack starts saving $5000 per year at age 35 and continues until age 65.  It turns out that although Jill invests a total of $50,000 ($5000/year for 10 years), while Jack invests a total of $150,000 ($5000/year for 30 years), at a 7% compound annual return, Jill actually ends up with more money at age 65!  Jill ends up with $562,683 while Jack ends up with $505,365.

Let's do a similar analysis, but assume Jill still starts saving/investing at age 25, but continues to invest $5000/year until age 65, and Jack starts investing at age 30 instead of waiting until age 35 (a scenario more closely matching my friend's daughter's idea of waiting 5 years before beginning to save and invest).  Assuming the same 7% compound annual return, Jill ends up with $1,068,048 and Jack ends up with $739,567; i.e., Jill starts investing only 5 years earlier, and invests only $25,000 more than Jack, but ends up with $328,481 more at age 65.

It's hard for young people (perhaps most people) to grasp the impact that starting to save and invest just a few years earlier can have.  It's hard for them to think in terms of saving and investing for 40 years or more.  However, it's critical for us to try and help them do so, since as we've seen, it can have a dramatic effect on how much money they end up with in retirement, and thus how likely they are to be able to retire comfortably.

Below is the spreadsheet that shows the two Jack and Jill cases.  Use the horizontal scroll bar to scroll to the right to see Case 2 in full.  Use the vertical scroll bar to scroll to the bottom to see the final values and total contributions.


  1. Not long after writing this article, I ran across two examples similar to the Jack and Jill example I used. This just shows how common this approach is to try and get this across to people.

    In The Complete Idiot's Guide to Protecting Your 401(k) and IRA, they show you starting at age 25, and contributing $2,000/year to a Roth IRA and stopping after age 35 (11 contributions, $22,000 total), while your friend starts at age 35 and contributes through age 55 ($42,000 total). Assuming a 5% annual return, you end up with $75,390 ($53,390 in interest) at age 55, while your friend ends up with $71,439 ($29,439 in interest).

    In an article in Schwab's "On Investing" magazine, they show Sarah starts saving $6,000 annually at age 30 and stops 10 years later, while Ted starts at age 40 and continues until age 65 (more than twice as long as Sarah). Assuming a 7% annual return, Sarah ends up with $466,810 while Ted ends up with $393,735, so Sarah ends up with over $73,000 more than Ted, even though she saved less than half as much.

  2. Wow, Dad this is great! This is a perfect subject for someone like me who is about to enter the workforce. Do you have any basic beginning tips to someone who is just starting to work? Tips on the VERY first steps toward saving/investing? This would be VERY helpful. :)

  3. OK, I'll try to do that in my next entry.