The Penalty of Starting Late

This post ties in with my last post. It is unfortunate that young people don't understand the power of compounding. I just did a quick spreadsheet comparing different savings scenarios. The penalty for waiting just 5 years to start saving money is huge.

For my example I used a 25-year old (known as the "Early Bird")who puts $3,000 per year away. I assumed a 12% return. By the time this 25-year old reaches age 40, they will have approximately $141,000 in savings. What happens if this 25-year old decides to wait five years before they start saving money? A 30-year old (known as "Slow Poke") who starts saving $3,000 per year and gets the same 12% return will have $68,000 by the time they are 40 years old.

The numbers are amazing:

Early Bird's scenario looks like this:

               Total Contributions     $48,000
     Account Balance at Age 40    $141,681
                Account Growth     $93,681
% of Account Value from Growth      66.12%

Over 66% of Early Bird's account value comes from growth. You get that growth by starting early.

Now let's look at Slow Poke's account:

               Total Contributions    $33,000
     Account Balance at Age 40    $68,281
                Account Growth    $35,281
% of Account Value from Growth     51.67%

Only 51% of Slow Poke's account value comes from growth.

The point of all this is that is important to start saving as soon as you can. Granted, I used straight-line numbers in my calculations, and there are no guarantees that a person can get a 12% return. But, over the long-run, investing your money is going to give you a better retirement than relying on Social Security.

Tags: The Power of Compounding, Starting Young, Investing Early