Want to hear a scary statistic?
It can be easy to prioritize other financial goals over retirement when you’re young, because retirement seems so far off.
Unfortunately, before you know it, retirement will be here – and you’ll either be able to pay for it or you won’t.
While this is a heartbreaking statistic, if you’re in the same boat, there’s good news; it’s never too late to start investing for your financial future – you just have to be more diligent about it if you’re starting later.
In this post, you will learn about the power of compounding and compound interest, and learn why it’s never too late to start investing for your financial future.
What is Compounding and The Power of Compound Interest
Before we get into some tips on how to save more to invest for retirement, it’s helpful to see an example of just why it’s so important to start investing as soon as possible.
Two words – compound interest.
Most people are familiar with the term interest – the money you get in return for loaning money to a bank, for example.
But compound interest is an even greater being.
Compound interest is the money you earn on your initial investment, plus the money you earn from accrued interest.
Simply put, it’s the interest your interest earns.
For example, let’s say you put $1000 into the stock market, and you average a 10% return every year. After that first year your investment gained 10%, or $100.
While this is an amazing thing – yay, free money! – even better is what happens a few years later when compound interest starts taking over.
Let’s see how it affects your investment using a compound interest calculator from the IRS website.
After 10 years, you would have earned a total of $1,593.74 in interest without contributing anything more.
You can see how during the first few years, our investment returns don’t make us much.
But once compound interest starts to take over, it really starts to take off!
Even with an amount as small as $1000, over time, the interest you earn from your investment and the interest your interest earns really starts to affect your returns.
This is why it’s so important to start investing early – because compounding takes time.
The point of this example isn’t to make you feel bad – it’s to help you understand how much compounding interest can help you reach your financial goals.
The Impact of Time on Compounding and Time in the Market
Another important factor when it comes to investing is time. Time allows compounding interest to do the heavy lifting for us.
In order to drive the point home, let’s look at an example between two different investors: one with 15 years until retirement, and one with 25, with identical salaries, investment returns and contributions.
Investor A makes $50,000 a year, invests $100 a month, and has 15 years until retirement.
Here’s how much his account would be worth after that 15 years at 10% interest:
These investing results are pretty good!
Let’s compare that to investor B, who also makes $50,000 a year, invests $100 monthly, but has 25 years until retirement.
Here’s how much his account would be worth after that 25 years at 10% interest:
Even with both investors making the same amount of money, and contributing the same amount to their investments, investor B has almost three times the amount of money as investor A after only 10 additional years of investing, and only $12,000 additional capital invested.
This is a perfect example of why time in the market is more important than almost any other factor.
How to Save for Retirement with Limited Time
Let’s say you’re like Investor A, with not much time until retirement.
Is it even possible for you to retire with enough savings?
The easiest way to determine if and when you can retire is to determine how much you’ll need in retirement, then divide that amount by the amount of years you have until you retire.
For example, let’s say you are 50 years old and expect to retire at 65 with $500,000. You have no money saved and you don’t have access to a 401K.
In order to determine how much you’ll have to save for retirement, we have to figure out how much we need to save per year.
$500,000 / 15 years = $33,333.33 a year, or $2,777.00 a month.
That is a lot of money, but depending on your income and expenses, it can be done.
But in order to do that, you need to start saving more.
If you’re trying to play catch-up, here are some small steps that can yield big results.
The Impact on Retirement of Getting a 401k Match at Work
If you have an employee-sponsored 401k and you work for a company that will match your contribution up to a specific dollar amount, you need to take advantage of it.
Every dollar helps, and not taking a match is like throwing free money away.
Taking that match, whether it’s 2% or 5%, can have a drastic effect on your investment returns and timeline.
Let’s use an example.
Investor A makes $50,000 a year, has 25 years until retirement, contributes $125 a month to his retirement but gets no additional match from his company.
Investor B makes $50,000 a year, has 25 years until retirement, contributes $125 a month to his retirement and gets a match on his 401K contributions (an additional $125 a month, $250 total contribution).
Let’s take a look at the results:
While it’s not unsurprising that Investor B has more money at retirement, it is crazy to see how much more he has, just from an additional $1,500.00 being contributed to his account every year.
Obviously, if you’re getting any sort of match at all, you need to take it!
Increase Your Contributions Every Few Years (or as Often as you Can)
Another great way to beef up your retirement savings is to increase your contributions as often as possible.
Here’s an example.
Investor A contributes $125 a month to his retirement and does not contribute any extra over the course of his 25 years until retirement (and receives no company match for simplicity sake).
Here’s what he would be left with at the end of those 25 years if he started from $0 at a 10% interest rate (this is the same table from above):
Let’s contrast that to Investor B, who also contributes $125 a month to his investments, but who, every five years, increases his contribution rate by 2% (for the sake of this example, Investor B gets no company match either).
So at age 40 he’s contributing 3% ($1,500 per year), at age 45 he’s contributing 5% ($2,500 per year), at age 50 he’s contributing 7% ($3,500 a year), at age 55 he’s contributing 9% ($4,500 per year) and at age 60 he’s contributing 10.5% ($5,250).
*Because this information is harder to calculate by graph, I did it by hand.
Here are the results:
Investor B is left with almost $350,000 more dollars in retirement, just by gradually increasing their contribution rate over 25 years.
This is a perfect example of how contributing a little extra every month every few years will get you to financial independence much quicker than not raising your contributions at all.
After 50, You Can Contribute More to Retirement
You may not know, but if you’re over 50, you can actually contribute a little extra to your 401K and IRAs.
In 2019, the maximum contribution for a 401K is $19,000. If you’re over 50 though, you can contribute an extra $6,000 per year, for a total of $25,000 a year!
In 2019, the maximum you can contribute to an IRA (either Traditional or Roth) is $6,000, plus an additional $1,000, for a total of $7,000 a year.
This little extra contribution room can help bridge the gap between what you have currently saved, and what you might need.
Save, Save More, and Keep Saving!
If, and when, you get a raise, pretend you didn’t and take the extra to increase your contribution.
If, and when, you get a tax return, pretend you didn’t and take the extra to increase your contribution.
If, and when, you sell things around the house, pretend you didn’t and take the extra to up your contribution.
If you have a side-job and are earning some extra income, pretend you’re volunteering instead and channel those funds into an IRA and get the benefit of no tax when you withdrawal at the time of retirement.
For hourly employees, if and when you get overtime pay, pretend you didn’t and take the extra to increase your contribution.
If you ever receive an inheritance, pretend you didn’t and increase your contribution.
If you receive a settlement, take as much of those funds after you pay lawyers, and other bills to increase your contribution.
If you’re still trying to catch-up and have maxed out your 401k ($19,000 or $25,000 for employees 50 or over) and IRA ($6,000 or $7,000 for employees 50 or over), just remember that you can always contribute after-tax dollars to a brokerage account and purchase one of many low cost index funds.
It’s Never too Late to Start Investing
It’s never too late to start investing and contributing to your financial future.
While it may be more difficult for you depending on your age, your income, and your access to benefits such as a 401K, with time, it can be done.
There’s a wonderful Chinese proverb that is relevant to starting to invest:
“The best time to plant a tree was 20 years ago. The second best time is now.”
So start contributing to your financial well-being today, and get on the way to financial freedom.
The future you is depending on it!