Cost of delay when saving for retirement
There are lots of questions that come with retirement planning. How much risk should you take? Which types of savings accounts are best? How should you be allocated? How much do you need to save?
These are all common retirement questions that may not have definitive right or wrong answers. However, there is one question for which the answer is always the same.
When should you start saving for retirement? As soon as possible.
The effects of starting early can’t be overstated. For example, consider two friends, John and Mark, who both started their careers at age 25. John immediately starts saving £5,000 for retirement and continues to do so until he retires at age 65. Mark waits 10 years to start saving, but when he does, he saves £10,000 per year. Like John, he saves until he retires at age 65. They both earn an average annual 8 per cent.
Who do you think has more money at retirement? Keep in mind, Mark saved a total of £300,000 while John saved a total of £200,000. Surely the person who saved 50 per cent more money will have the higher total at retirement, right?
Wrong. Even though John saved two-thirds the amount that Mark saved, he still ends up with more money. John retires with £1,399,000 at retirement. Mark heads into retirement with £1,223,000.
How is it possible that someone could save less money, make the same return every year, and still end up with more money at the end? It boils down to the power of compounding returns. John and Mark did get the same 8 per cent return each year. However, John got his for 10 more years than Mark.
When returns are compounded, it means that any growth is applied to the previous end-of-year balance. For example, in John’s first year, he invested £5,000 and got an 8 per cent return. At the end of the year, his savings account was worth £5,400. He made £400. In the second year, he adds another £5,000 and gets an 8 per cent return on that plus his £5,400 balance. His end-of-year balance is £11,232, for an £832 gain.
In year 10, when Mark is just starting, John’s balance is just north of £78,000. They both get an 8 per cent return that year. However, John’s 8 per cent return on his balance is £6,240. His returns only grow larger in the future because of the power of compounding.
To get the most out of compounded returns, you have to give the investment time to grow. This is why at deVere Group we advise that the time to start retirement planning is now. Even if it’s a small amount every month, starting early can have a substantial impact in retirement.