The earlier you start saving for retirement, the longer your investment time horizon becomes. The longer your money stays invested, the greater the potential to accumulate wealth. This is due in large part to the power of compounding, or earning interest on top of interest over time.
Postponing contributions to a retirement plan just a few years can cost you thousands of dollars in lost compounded growth potential. And delaying as much as a decade or more might produce a six-figure savings shortfall.
Let’s see how this works by meeting two hypothetical young educators, Jenna and Hannah, with two different approaches to saving for retirement.
Save now or later?
Jenna and Hannah are both 25 years old, and looking forward to long teaching careers. They understand the importance of saving their own money to help supplement their state pensions. Jenna crunches the numbers in her household budget and makes a firm commitment to invest in her future by socking away $200 a month in a 403(b) plan at work.
But Hannah can’t quite see the advantage of saving for something so far away, so she decides to wait 10 years before she starts contributing $200 a month to a 403(b) plan. Hannah figures that still gives her 25 years to save for an expected retirement at age 60, so she feels pretty good about her decision. They both earn an average return of 5% a year.
Take a look at the difference a decade makes by studying the chart below. Waiting 10 years to start saving costs Hannah $108,116 in lost savings compared to Jenna. That’s enough to make a significant impact on Hannah’s retirement lifestyle.
This hypothetical illustration does not reflect or predict the returns of any specific investment. Assumes systematic contributions of $200 at the beginning of every month. Systematic investing does not ensure a profit or guarantee against loss. Taxes and fees are not reflected. Your results could be higher or lower depending on market factors.
Over the course of 35 years, Jenna contributes $24,000 more than Hannah, who contributes for just 25 years. But Jenna ends up with over $108,000 more than Hannah. That’s the power of compounding.
Calculate your potential “wait” loss
Use this Simple Savings Calculator from Bankrate.com to see how much it could cost you to wait before contributing to a savings plan. Keep in mind that if you wait to get started, later on you may have to employ some combination of saving a lot more, investing more aggressively and maybe delaying retirement (to extend your time horizon), to make up for lost time and achieve similar savings goals.
The bottom line
Never underestimate the power of compounding over a few extra years of saving. Invest in your future and resolve to start saving as early as you can in your career. You could see quite a difference in dollars when you decide to retire.
