an excerpt from a book I began to write 4-5 years ago
Although it is my desire to create a book that is useful to people of all ages, I am especially hoping to reach young people, who are just beginning their financial journey. Habits we establish when first we enter the working world will make all the difference when we reach major financial milestones in our lives, such as marriage, buying our first home, or getting ready for retirement or a career change.
Young people also have an advantage when it comes to benefiting from the compounding effect of time on savings and investments, and enjoy lower rates on life and health insurance premiums.
Compounding Effects
When I was very young, Gibraltar Savings and Loan had a radio commercial jingle that stuck in my brain and remains there today (I even remember the tune!):
“At Gibraltar, daily interest, compounded daily. From the day you put your money in, till the day you take it out!”
We’ll get into the subject of compound interest later, but let me first talk about the value of time when it comes to saving money for a specific goal. Let us first consider a very old method of saving money - stashing it in your mattress or burying it in a coffee can. There are some drawbacks to these methods, such as vulnerability to theft or fire, but some people do save up their money by the piggy bank method, and it will serve to make a point or two about the value of time.
If we begin to save money for a goal by putting a dollar a day into a piggy bank, simple arithmetic will show us that at the end of a week we’ll have $7. At the end of the month we’ll have $30 and at the end of the year we’ll have $365. So, if we want to begin saving towards retirement at age 65, the sooner we begin, the better off we’ll be. If we begin to save at age 18, even a dollar a day will yield $17,532! If we wait till age 40 (far more likely to be the age we begin thinking about retirement), the same dollar a day habit will only yield $9496.50!
We can plainly see that even when it comes to simple savings, it is best to start early.
Once we begin to combine the accumulation effect of time with the effect of compound interest, we can really see the benefits. For example, we once again begin to save $1 a day, but instead of putting it into a piggy bank, we place it in an interest bearing account at a financial institution. We’ll assume that we can get 3% interest on a passbook savings account, compounded monthly. If we begin to save for retirement at age 18, by age 65 our savings will have grown to just over $37,000. If we wait until age 40 to begin saving, then the savings will only total slightly more than $14,000.
So, what happens when we double our interest rate in a plan such as this? We would expect our savings to double, right? Wrong. The effects of compounding over time are surprising. If we saved a dollar a day from age 18 to age 65, and placed it in a short term bond fund earning 6%, we’d end up with almost $94,000! Again, as in our previous example, if we start at age 40, we only accumulate $22,442. The penalty for starting late is more than $71,000!
One final note regarding interest, or rate of return. If we’re able to put our money into an equities mutual fund which averages a 12% return over the long haul (not at all improbable), then the dollar a day put into savings from age 18 to age 65 will become $818,000! That sounds like just about enough to retire on, but I hear young people say to me all the time, “I can’t afford to put money away for retirement.” Remember that this example starts with saving only $1 per day. Do this consistently and persistently over time and the rewards are enormous. How much is that daily cup of Starbucks skinny latte costing you?
As an aside for those of us who are parents, or expect to become such. Do the same thing for your child, from the day they are born, put a dollar a day away for them. At the end of each month or year, shift the money to an account with the highest rate of return that you can obtain. Assuming a 12% average rate of return in an equities fund, you’ll be able to hand your child about $20,000 the day they graduate from high school. There’s a lot of good uses for that money, but consider this: If your child has learned their lessons well from watching you save over the years, they can roll that money over immediately into their own IRA, and at age 65, they’ll have more than 3.7 million dollars! All without adding another dime!
Young people also have an advantage when it comes to benefiting from the compounding effect of time on savings and investments, and enjoy lower rates on life and health insurance premiums.
Compounding Effects
When I was very young, Gibraltar Savings and Loan had a radio commercial jingle that stuck in my brain and remains there today (I even remember the tune!):
“At Gibraltar, daily interest, compounded daily. From the day you put your money in, till the day you take it out!”
We’ll get into the subject of compound interest later, but let me first talk about the value of time when it comes to saving money for a specific goal. Let us first consider a very old method of saving money - stashing it in your mattress or burying it in a coffee can. There are some drawbacks to these methods, such as vulnerability to theft or fire, but some people do save up their money by the piggy bank method, and it will serve to make a point or two about the value of time.
If we begin to save money for a goal by putting a dollar a day into a piggy bank, simple arithmetic will show us that at the end of a week we’ll have $7. At the end of the month we’ll have $30 and at the end of the year we’ll have $365. So, if we want to begin saving towards retirement at age 65, the sooner we begin, the better off we’ll be. If we begin to save at age 18, even a dollar a day will yield $17,532! If we wait till age 40 (far more likely to be the age we begin thinking about retirement), the same dollar a day habit will only yield $9496.50!
We can plainly see that even when it comes to simple savings, it is best to start early.
Once we begin to combine the accumulation effect of time with the effect of compound interest, we can really see the benefits. For example, we once again begin to save $1 a day, but instead of putting it into a piggy bank, we place it in an interest bearing account at a financial institution. We’ll assume that we can get 3% interest on a passbook savings account, compounded monthly. If we begin to save for retirement at age 18, by age 65 our savings will have grown to just over $37,000. If we wait until age 40 to begin saving, then the savings will only total slightly more than $14,000.
So, what happens when we double our interest rate in a plan such as this? We would expect our savings to double, right? Wrong. The effects of compounding over time are surprising. If we saved a dollar a day from age 18 to age 65, and placed it in a short term bond fund earning 6%, we’d end up with almost $94,000! Again, as in our previous example, if we start at age 40, we only accumulate $22,442. The penalty for starting late is more than $71,000!
One final note regarding interest, or rate of return. If we’re able to put our money into an equities mutual fund which averages a 12% return over the long haul (not at all improbable), then the dollar a day put into savings from age 18 to age 65 will become $818,000! That sounds like just about enough to retire on, but I hear young people say to me all the time, “I can’t afford to put money away for retirement.” Remember that this example starts with saving only $1 per day. Do this consistently and persistently over time and the rewards are enormous. How much is that daily cup of Starbucks skinny latte costing you?
As an aside for those of us who are parents, or expect to become such. Do the same thing for your child, from the day they are born, put a dollar a day away for them. At the end of each month or year, shift the money to an account with the highest rate of return that you can obtain. Assuming a 12% average rate of return in an equities fund, you’ll be able to hand your child about $20,000 the day they graduate from high school. There’s a lot of good uses for that money, but consider this: If your child has learned their lessons well from watching you save over the years, they can roll that money over immediately into their own IRA, and at age 65, they’ll have more than 3.7 million dollars! All without adding another dime!