The high cost of waiting to save for retirement
This is the story of two friends. Randy, age 25, recognized the importance of starting a retirement savings program. Peter, also 25, couldn’t see beyond wanting to experience the kind of lifestyle enjoyed by his friends who made significantly higher income.
Randy established a registered retirement savings plan (RRSP) and begin saving $800 per month, about $10,000 a year, which generated an average annual return of six percent. At age 45, Randy was forced to stop working due to health reasons, so he collected Canada Pension Plan (CPP) Disability Benefits and stopped contributing to his RRSP. After 20 years of investing, his retirement account had grown to over $360,000.
Peter waited before getting serious about saving for retirement. A part of his rationale was that he would be making more money later on, which would allow him to catch up with bigger monthly contributions. Peter waited until he was 45 to begin saving, about the same time that Randy stopped contributing to his plan. With 20 years left to save, Peter figured he would have plenty of time to build his nest egg. However, unable to adjust his lifestyle as much as he needed, he was only able to commit to an $800 a month savings plan. He too invested in an RRSP that was able to generate an average annual return of six percent. After 20 years, his account value grew to over $360,000.
So, here we have two friends – the same age; contributing the same amount of money; and earning the same rate of return. One started saving early, and the other waited. However, while Peter was making his contributions, Randy’s account continued to grow in value, even without new contributions. In fact, by the time they both turned 65, Randy’s account had grown to nearly $1.2 million! Same amount invested; same return on investments. The only difference – and it is a monumental difference - is how they utilized their most valuable asset – time.
Please note, the exact dollar values in the preceding story are based on best estimates and do not take into account external factors and real-life fluctuations that may occur, and real results may vary from financial institution to financial institution. You must consult a qualified financial specialist to receive accurate and personalized information regarding your own finances.
Yes, there is a cost for waiting
The moral of the story is that not everyone recognizes that time is not only our most valuable asset, it’s also a diminishing asset. Peter’s story demonstrates that there is a monetary cost to waiting.
For Peter to financially catch up to Randy by age 65, he would have had to have saved more than four times as much and/or assumed much more risk to earn a higher return, when he started at the age of 45. Time can also mitigate risk; often we are able to incur less risky investments because of the longer length of time that our money can work for us. Essentially, the more time you have, the less it will cost you to achieve your goals. When you’re young, you usually have more time than money, and it’s important to make use of the assets at your disposal while you still have them.
Embrace the use of compounding returns
As the great Albert Einstein once said, “the power of compound interest is the most powerful force in the universe” and “the greatest mathematical discovery of all time."
The exciting part about compounding returns is the fact that your money not only earns a return on the principle, but also, it earns a return on the principle plus previously earned interest. The “time value of money” is the key to making the most out of compounding returns. Compounding returns over time can turn even the smallest amount of savings into a significant fortune.
*This content is developed from sources believed to be providing accurate information. The information provided is not written or intended as tax or legal advice and may not be relied on for purposes of avoiding any federal tax penalties. Individuals are encouraged to seek advice from their own tax or legal counsel. Individuals involved in the estate planning process should work with an estate planning team, including their own personal legal or tax counsel. Neither the information presented nor any opinion expressed constitutes a representation by us of a specific investment or the purchase or sale of any securities. Asset allocation and diversification do not ensure a profit or protect against loss in declining markets. This material was developed and produced by Advisor Websites to provide information on a topic that may be of interest. Copyright 2014-2015 Advisor Websites.