A:

In general, the earlier you start saving for retirement, the easier it will be to afford, given the number of financial obligations that tend to be incurred at that later period in your life. A closer look at the interesting aspects of compounding will illustrate how, in the retirement game, the early bird really does get the worm.

Consider two hypothetical twins, Earl and Lance. They are both 25 years old, fresh out of college and ready to start building their retirement nest eggs.

Lance decides that he'd rather enjoy a comfortable lifestyle right away, rather than scrimping and saving like he did in college. Lance reasons that he will be able to save a large chunk of money in his middle-age, because he expects to be earning much more by then. He decides not to contribute to his nest egg for the first 10 years of his career, and then contributes $3,000 per year for the next 20 years of his life.

Earl decides to start saving for his retirement immediately. Earl can only afford to contribute $1,000 to his nest egg each year. Ten years later, when Earl is 35, he decides that he can't afford to fund his nest egg any further.

Let's assume that Earl and Lance both invest their savings into an open-end mutual fund with a 15% annual return.

This table tracks each investor's nest egg at the end of every year until they are 55 years old. Keep in mind that Earl has only saved a total of $10,000. Lance has saved three times as much for twice as long for a total of $60,000.

easy_vs_late.gif

Earl's $10,000 has turned into a nest egg of more than $340,000, while Lance's $60,000 has grown to just under $314,000. This occurs because Earl is better able to make use of compounding than Lance. Notice that Earl's savings grow to more than $20,000 after 10 years, when Lance begins saving $3,000 per year. This may not seem like a big difference, but unfortunately for Lance it most definitely is. Even though Lance saves three times as much money as Earl and for twice as long, he is still not able to save as much money. In fact, the longer this time line continues, assuming a 15% return each year, the more Lance will fall behind.

Put another way, the dollars that you save in your youth are actually worth much more than the dollars you save near your retirement. The earlier you can contribute savings to your nest egg, the more time they will have to grow. When it comes to paying for a comfortable retirement, therefore, one of the biggest allies you have is time, provided that you start early. If you wait too long, time can become your enemy.

(To learn more, read Retirement Planning Basics, Delay In Saving Raises Payments Later On and Determining Your Post-Work Income.)

RELATED FAQS
  1. How soon should I start saving for retirement?

    Learn about the basics of retirement planning and the reasons why it is so advantageous for individuals to start saving for ... Read Answer >>
Related Articles
  1. Retirement

    Save Now To Retire Earlier - Or Just Work Longer?

    Working longer might seem a solution, but job and health risks make it an unreliable option. Compound interest, though, means savings always make money.
  2. Retirement

    Will Your Retirement Income Be Enough?

    Find out how to determine whether you're on the path to a comfortable retirement, or financial ruin.
  3. Retirement

    Why Saving 10% Won't Get You Through Retirement

    Retirement experts often tout the 10% rule: To have a good retirement, you must save 10% of your income. The truth is, most people need to save far more.
  4. Retirement

    In Your 20s? Don't Risk Delays in Retirement Savings

    Saving for retirement in your 20s can be challenging, but waiting to start can put your long-term financial future at serious risk.
  5. Retirement

    Why You Need to Budget and Self-Fund Retirement

    Make retirement savings a priority because costs are rising and Social Security won't be enough.
  6. Retirement

    What Your 401(k) Can Look Like in the Next 20 Years

    Discover how time and compounded growth of earnings can help even a modest 401(k) plan balance grow to a significant sum over a period of 20 years.
  7. Retirement

    Anytime Is The Right Time To Start Saving For Retirement

    If you're looking to start building your nest egg but don't know how to do it, read on. We give you a few easy tips on how to save.
  8. Financial Advisor

    10 Tips for Achieving Financial Security

    Follow this sound advice and plan for a comfortable future.
RELATED TERMS
  1. Nest Egg

    A substantial sum of money that has been saved or invested for ...
  2. Savings Rate

    The amount of money, expressed as a percentage or ratio, that ...
  3. Pay Yourself First

    A phrase commonly used in personal finance and retirement planning ...
  4. National Savings Rate

    An estimate from the U.S. Commerce Department's Bureau of Economic ...
  5. Millennials: Finances, Investing, & Retirement

    The generation born between 1982 and 2004. The Millennial generation ...
  6. Savings Account

    A deposit account held at a bank or other financial institution ...
Hot Definitions
  1. Index

    A statistical measure of change in an economy or a securities market. In the case of financial markets, an index is a hypothetical ...
  2. Return on Market Value of Equity - ROME

    Return on market value of equity (ROME) is a comparative measure typically used by analysts to identify companies that generate ...
  3. Majority Shareholder

    A person or entity that owns more than 50% of a company's outstanding shares. The majority shareholder is often the founder ...
  4. Competitive Advantage

    An advantage that a firm has over its competitors, allowing it to generate greater sales or margins and/or retain more customers ...
  5. Mutual Fund

    An investment vehicle that is made up of a pool of funds collected from many investors for the purpose of investing in securities ...
  6. Wash-Sale Rule

    An Internal Revenue Service (IRS) rule that prohibits a taxpayer from claiming a loss on the sale or trade of a security ...
Trading Center