Why You Should Be A Long-Term Saver

Posted on February 7, 2014 at 10:15 AM PST by

Time is money, according to the business dictum. When it comes to retirement, it’s literally true.

Most savers believe that their retirement will grow more if they save more, which is correct. They also hope that investing will result in their savings being more in time. Also a likely outcome.

What few understand, however, is just how much time is a factor in making those two forces work in concert.

The trick lies the magnifying effect of compounding. Picture two young savers. One is Sandra, the other is Sam.

Sandra has a pretty good job in retail. She earns $35,000 right out of college and works long hours. She decides to start saving and immediately begins to defer $5,000 a year, beginning at age 24. She earns a market rate of 7% on her money.

Sandra keeps at it for 40 years but never raises the amount she saves. Thanks to compounding, at age 64 she has close to $1.2 million.

saver

Sam is a store manager and makes similar money, but he is a spender. He saves nothing from age 24 to age 44. Then he wakes up one morning and realizes he needs a better plan. So he starts saving.

Question: How much does Sam need to save to keep up with Sandra?

In rough terms, Sam must put away $25,000 a year to have the same $1.2 million within his shorter, 20-year savings window. The difference is Sandra’s 20-year head start. All those years that Sam was spending, Sandra was saving.

Presumably, both got raises over the years of their career. Yet it’s unlikely that Sam will get enough in raises to come up with such a high savings rate late in his career.

Sam can still try to retire by saving $5,000, but to make it work he needs an 18% return — basically, credit card rates — for all 20 years.

Saving even a little more can have a huge long-term effect. Let’s say Sandra finds the tax-deferral aspects of her workplace 401(k) really attractive, so she ups her goal. The company also gives her a nice matching contribution.

Sandra bumps her savings rate up to $8,500 a year. At retirement, then, she’s sitting on almost $2 million. The income flow from a $2 million portfolio, broadly speaking, is $80,000 a year.

Your retirement lifestyle

At that level, Sandra could easily continue her lifestyle right into retirement, perhaps even retire early and travel.

Sam, on the other hand, will hit a brick wall at some point, realizing that he must work well into his 70s or later just to get by.

Compounding is not magic, it’s just math. But it’s powerful math that any working person can deploy by simply taking the decision to save steadily and to start saving as early as possible.

Having choices later in life is a sweet reward for so simple a decision.




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