Why aren’t you saving? Understanding the consequences
Waiting to start saving for retirement? You’re not alone. According to a survey from the Employee Benefit Research Institute, only 57 per cent of Americans are actively saving for retirement. The situation isn’t any better on the other side of the Atlantic. A study from the National Institute of Social and Economic Research found that nearly 40 per cent of Britons were not saving for retirement.
It’s easy to delay saving. However, waiting to save can be more costly than you think.
Consider an example of two workers who join a company on the same day at age 21. Bob starts saving £100 per month immediately. Tom doesn’t start saving £100 per month for 10 more years, at age 31. At the point Tom starts saving, Bob has already saved £16,700, based on a 6 per cent average annual return.
More than 30 years go by and each man sticks to his savings plan. At age 65, they both retire. Bob has £253,000. Tom has £132,000, more than £120,000 less than Bob. When they started, Bob only had £16,700 more than Tom, so how can he have so much more now?
The answer lies in compounded returns. Albert Einstein called compound interest the eighth wonder of the world because of the magic it provides in growing assets. Compound returns are returns grown on top of the previous period’s returns.
For example, consider someone with a £100 who is earning an 8 percent compound return. After the first year, their balance would be their original £100,000 plus their 8 percent return, for a total of £108,000. At the end of two years, their total would be £108,000 plus an 8 percent return. This time, the 8 per cent isn’t £8,000. Rather, it’s £8,640, because that’s 8 per cent of 108,000.
As the balance of the account grows to higher amounts, so too does the amount of return earned every year. In our previous example, Bob only had £16,700 more than Tom at age 31. However, at a 6 per cent return, that £16,700 earned 1,002. That’s return that Tom isn’t earning and never will, unless he increases his annual contributions to a level substantially higher than Bob’s.
The longer you’re invested, the greater the impact of compound returns. The best way to take advantage of compound returns is to save early and regularly. Many people don’t save because they think they can’t afford it. However, even saving a small amount on a regular basis is better than not saving at all.
A great way to start is to set up an automatic transfer into a savings or investment account. If your employer offers a retirement plan, you should be able to have your contributions automatically deducted from your salary. Most people find that once the contributions start coming out, they don’t even notice that it’s missing.
Consulting with a financial adviser will help you determine how much you should save on a regular basis. Your adviser can design a custom retirement plan to help you get on a savings path to reach your retirement goals, amongst other important, long-term financial objectives.
To understand what to look for in a great financial adviser, download our free guide here.
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Blog published by Mike Coady