Investors fret about the performance of their portfolios. They worry whether they will be able to realize a rate of return sufficient to help them meet their goals and if they are taking on enough (or too much) risk to achieve this. While these are valid concerns, they are ultimately beyond anyone’s control. Other than diversifying broadly to lower volatility and keeping investment and tax costs low to increase net gain, there is nothing we can do to determine the actual rate of return on our investments; the markets will ultimately decide this fate for us.
There is, however, something outside of investing that we can all do that is completely within our control and that can have a great impact on whether we achieve our life goals. Indeed, by forming certain habits early, we can help reduce the rate of return that we need to realize on our investments and even how much we need to invest in the first place. I am referring to the habit of saving.
Perhaps the greatest risk we all face is not saving enough to meet our long term needs. Saving as much as we can and beginning this practice early allows our money to grow exponentially with time given the magic of compounding. Just how significant an advantage one can reap from an early commitment to saving can be illustrated in the following example.
Ben and Jerry are twin brothers. Ben decides to begin saving at age 30 at a rate of $10,000 per year. He continues this practice until the age of 40, at which time he stops saving altogether. Jerry waits until he turns 45 to begin saving. He puts away $15,000 per year until retiring at the age of 65. If we assume both brothers earned the same 7% average annual rate of return, how much did each accumulate by the age of 65?
First, let’s compare how much each brother socked away. Ben saved $100,000 in total over 10 years compared to Jerry who saved a whopping $300,000 over 20 years. In spite of having saved more over a longer period of time, however, it turns out that Jerry winds up with the smaller nest egg of the two. At age 65, Jerry’s savings will have grown to about $615,000, certainly a significant sum. In comparison, however, Ben’s savings will have grown to approximately $750,000, $135,000 more than Jerry in spite of Ben having only saved a third of what Jerry saved for half as long. This is the magic of compounding at work and a great example of why saving early is so beneficial.
The moral of the story is that we are more in control of our financial destinies than we think. By deciding to save early and often, we can minimize the need to risk our money in the stock market since even modest rates of return over long periods of time yield impressive sums. The secret to getting rich is to do so slowly, saving as much as we can for as long as possible. So take matters in your own hands and get started, now!