Save Early, Save Often

The fact that it is better to start saving for your eventual retirement when you are young is common knowledge. It doesn’t take a financial wizard to understand that if you start saving early you have more years to save, and therefore you will wind up with more money. Yet, this doesn’t capture the true power of saving early. The real power comes in having your money work for you longer, though this is hard to imagine without a demonstration.

Suppose you graduate from college and are offered a job paying $45,000 per year. Your mom is like me, and advises you to save ten percent of your earnings in your company’s 401(k) plan. You set up your account to have ten percent automatically contributed. Your plan offers a target date retirement fund, so you pick the one with a date 45 years in the future and never think about it again.

Target date retirement funds are fully diversified investment funds designed to be appropriate for the time you have until you retire. They generally have fund names that include the approximate date you will stop working. In this case the name might be Target Retirement 2060. They start out nearly fully invested in the stock market but gradually become more conservative as the time remaining until you retire gets shorter. Target retirement funds are one stop funds, so you don’t need other types of investments.

With a modest inflation rate of two percent per year, your salary and contributions increase over time, but never exceed $11,000 per year. Because you have chosen a target retirement fund, you are largely invested in the stock markets for most of your working career, giving you the best opportunity for growth. Assume your investments have an average annual return of 7.0 percent until you are 57. As the fund gets more conservative, your returns drop down to 5.0 percent for the rest of your career. Given all this, you will wind up with about $1,475,000 which is just about what you will need added to your social security benefits to maintain your lifestyle.

Your contribution to your nearly one and a half million dollars? $335,000. You only had to contribute less than a quarter of your balance. The remaining three quarters plus came from your money working for you. The amount of time it works for you is key to how much you have to save.

Let’s say instead, because of student loans or whatever, you don’t start contributing to your 401(k) until you are 32. After all, you still have 35 years to save. That should be good enough.

You can accumulate the same amount of money, but your contributions have to be much bigger. In every year you contribute, you need to contribute nearly three quarters more than you would have if you started saving at 22. That’s money you could use to save for your kids college education, or to take family vacations. Your total contributions to your balance is $494,000, $159,000 more than had you started saving ten years earlier. Still it’s not bad. You only have to contribute a third of your total balance.

OK, after you paid off your student loans your kids were in day care. Then they had sports and clubs you had to pay for. The dust finally doesn’t settle until you are 42. At last you have a little extra money to save in your 401(k). Unfortunately you need to contribute a lot of extra money to your account to save up the same amount. Your annual savings need to be more than three times your contributions had you started saving at 22. You have to contribute almost half of the $1,475,000. The following graphs compare the three situations.

retirement savings

Nobody’s life goes like these examples, but they demonstrate the point. Saving early on is very powerful. The more time your money has to work for you, the less you have to save. That is why other financial goals need to take a back seat to saving for retirement. If you wait, you may get around to doing what you need to eventually, but you will have to give up much more of your income to do it.

Image courtesy of Sira Anamwong at

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