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 >>
  2. What are the best ways to plan for retirement?

    Learn the basic steps to creating a solid retirement plan that can support you and your family, and find out how to manage ... 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

    Retirement Lessons To Teach Your Children

    If your retirement plan hasn't worked out, at least your children can learn from your mistakes.
  5. Retirement

    Retire From Work, Not Personal Financial Planning

    Here are some personal finance tips for those who want to live well after work ends.
  6. Financial Advisor

    Retirement Bliss? Not So fast: When Savings Lag

    Most people aren't saving enough for retirement. Here are some tips savers and financial advisors can use to change that.
  7. Financial Advisor

    Are You Saving Too Much?

    "Spend now! Don't worry about retirement," say some experts. Could they possibly be right?
RELATED TERMS
  1. National Savings Rate

    An estimate from the U.S. Commerce Department's Bureau of Economic ...
  2. Savings Account

    A deposit account held at a bank or other financial institution ...
  3. U.S. Savings Bonds

    A U.S. government savings bond that offers a fixed rate of interest ...
  4. Consumption Smoothing

    The ways in which people try to optimize their lifetime standard ...
  5. Retirement Contribution

    A monetary contribution to a retirement plan. Retirement contributions ...
  6. Spending Phase

    The period in a person's life following retirement in which earning ...
Hot Definitions
  1. Portfolio Investment

    A holding of an asset in a portfolio. A portfolio investment is made with the expectation of earning a return on it. This ...
  2. Treynor Ratio

    A ratio developed by Jack Treynor that measures returns earned in excess of that which could have been earned on a riskless ...
  3. Buyback

    The repurchase of outstanding shares (repurchase) by a company in order to reduce the number of shares on the market. Companies ...
  4. Tax Refund

    A tax refund is a refund on taxes paid to an individual or household when the actual tax liability is less than the amount ...
  5. Gross Domestic Product - GDP

    The monetary value of all the finished goods and services produced within a country's borders in a specific time period, ...
  6. Inflation

    The rate at which the general level of prices for goods and services is rising and, consequently, the purchasing power of ...
Trading Center