Last year, I signed up for a program called “Connections” through my college alma mater. The program is designed to bring a group of the college’s current juniors and seniors to the big city, for a pow-wow with both recent graduates and ancient grads like myself, who work in the students’ prospective career fields.
On the day of the confab, a handful of us alumni sat on the dais, facing a dozen fresh-faced undergrads. After we alums painted a verbal picture for the kids of the work world we inhabit on a daily basis, it was time for the question-and-answer session. It took a while, but then one coed held up her hand and asked, “What do you wish you knew when you were our age that you know now?”
It was the question I’d waited for, the one that allowed me to make what I hoped would be a significant contribution to the collective joy of the student group, not then but approximately four to five decades into the future.
“This isn’t so much a career issue as it is a life issue, ” I intoned. “But when I got handed my sheepskin with the rest of the Class of 1976 one sunny May Sunday afternoon in that bicentennial year, I wish I’d known this above all:
“I wish I’d known that my youth was a tool — a golden, glistening, priceless instrument of wealth accumulation — that I could leverage to accumulate vast financial assets, and do so fairly effortlessly. It took me a dozen years after graduation to grasp that lesson, and even that late in the game I still managed to parlay the wisdom into a nice, tidy sum. But I can only imagine what I’d been able to accomplish had I been hip to this truth a decade earlier.”
Off 180 degrees
Most college grads leave academia with a view of the future stretching to infinity. It’s so far off they can’t fathom turning 40, let alone picture their retirement years. Having spent 17 years — almost their entire lives — toiling away in the classroom to reach college graduate status, they’re convinced of one thing: They can start saving a lot later for the day seemingly centuries off when they retire. For right now, it’s time to reward themselves for all that work by spending, not saving.
In making that assumption, they’ve got it wrong — exactly 180 degrees wrong. That’s because the most important, powerful savings they will ever put away are the savings they bank the very first day they are ever paid. The second most powerful savings? The savings banked the day after the first day they are paid.
By the time paychecks are handed to people in their 50s or even their fairly youthful 40s, some of the power to grow savings those folks once enjoyed has been sapped. There are fewer years left until they retire, or are forced out the workforce by a younger boss who doesn’t much care for older workers.
That means there are fewer years for savings to compound. Compounding was once referred to by Albert Einstein as the “Eighth Wonder of the World, ” because of its amazing way of growing savings over long periods.
“Compound interest is the Eighth Wonder of the World, ” remarked the Great One. “He who understands it earns it. He who doesn’t understand it pays it.”
Put savings into a tax-advantaged account, such as a 401(k), if offered one at work, or an Individual Retirement Account, and you have the Eighth Wonder of the World on steroids. It’s not only that your principal is making interest every year, and your interest is making interest every year, and your reinvested dividends are making interest every year.
It’s not even that all that together is building and building, year after year. In a tax-privileged account all of those gains are not taxed year to year, so they grow at an even faster clip. Wait even one paycheck to start saving, and you have a two-week shorter time frame for that miracle to weave its magic. The result is that the most powerful two-week period you’ll ever have to save has been wasted. Think two weeks of savings probably won’t amount to much? Try compounding them in a tax-deferred savings vehicle for 45 years and you may reassess the notion.
A few years ago, a study looked at two groups of savers. One group started saving at 25, saved x number of dollars a year until 35, and never saved again. This group just let those savings build through the power of compounding.
A second group of savers started the day after the first group stopped saving. Starting at 35, they saved the same x number of dollars a year for not 10 years but 30 years, all the way to traditional retirement age at 65.
What group came out ahead at 65? That’s right. It’s the first group. The fact they saved earlier more than compensated for the fact that they saved much less.
If you’re starting off fresh from college, you too have a golden, gleaming tool called at your disposal. No it’s not zero-percent balance transfer credit cards or knowing how to save on car insurance. It’s what Einstein called the Eighth Wonder of the World.
Don’t leave that tool in a closet and pull it out when you’re middle-aged. Use it from the very first day, when it has the most power.
After leveraging the Eighth Wonder of the World for four or five decades, you just might be able to take the rest of your life off, feeling free to visit the first seven.
4 Responses to “Meet the Enemy of Retirement Security: Procrastination”
Well written article that should be read by all college age students. It’s not that hard at that age. If the money is truly for retirement, keep it simple, and buy one highly diversified fund like Vanguard Total World Index (Ticker: VT). You can get more complex when you get older and have more money. Starting now is the best thing you can do.
I started saving for retirement ASAP (when I was 10, I started funding a Roth IRA). I created a habit early. Now I will easily be FI by age 30. Never too early to start!
A better example that points out the same phenomenon appears on page 21 of The Truth About Retirement Plans and IRAs by Ric Edelman. He tells the tale of a fictional Jack and Jill. Jack accumulates $40,000 by saving $5,000 for the eight years between ages 18 and 26, but never saves again. Jill starts at 26, when Jack stopped, and saves the same amount until 65, saving $200,000 in the process. Jack finishes ahead by hundreds of thousands of dollars, despite investing one-fifth the amount Jill did, by leveraging the miracle of compounding.
Do you have a link to that study – was it published? I’d love to look at the data.