One of the best things you can do for yourself at a young age is to front load your retirement. What does that mean exactly? Well, a lot of it is taking the opportunity when your expenses are lower to put more funds into your retirement accounts. This will give you a HUGE leg up going forward.
Keeping Your Expenses Down
Since life gets more expensive, it’s better to take advantage of a time when your expenses are generally much lower than your income to shovel as much as possible at your retirement. As an example, for many of those that go to college, scrimping by is fairly standard. Then, the first salaried job is landed after college and many will start stretching their legs by buying a new car or any other myriad of lifestyle creep increases. If these funds were taken and instead put towards retirement, less will need to be saved over time because of compound interest.
I understand that this will not be everyone’s situation, but for those lucky enough to be in the situation where their income far exceeds their current expenses, taking advantage of compound interest is one of the best uses of those excess funds.
The Magic of Compound Interest
Compound interest is the interest on a loan or investment that accumulates over time based on a percentage of both the original principal and already accumulated interest. An example of that would be if you have invested $100 that earns 5% interested. The next accumulation period would then be 5% on the total of $105 being your principal and interest from the last period. For loans, this works against you and increases the amount you owe over time, which is why it is cheaper to pay off a loan sooner rather than later. However, in investing, this works in your favor. In fact, it can work in your favor to the point where your money earns enough interest to pay for your living expenses, a.k.a. lifestyle creep.
The math doesn’t lie. Using the Investor.gov compound interest calculator, I ran the following scenarios:
Henry started saving $100/month for his entire working career. Assuming a 6% rate of return, Henry had a total of $142,471 at the end of 35 years.
Alice, on the other hand, started out saving $500/month for the first 5 years. Unfortunately, after 5 years, she was unable to save any more money. After the same 35 years and rate of return, Alice had a total of $210,097.
Even though Henry contributed more money over time than Alice did, the fact that her contributions had more time to accrue compound interest paid off to the tune of an additional $67,626 over 35 years.
Set It and Forget It
One of the best things that you can do to set yourself up for success is to automate your retirement contributions. This works especially well if you can do so through your employer where your 401k/403B/457 contributions come directly out of your paycheck. If you never see them, you will never miss them.
Additionally, many employer plans have the option to automatically increase your contributions on an annual basis by 1%. If this option is available to you, I strongly suggest you take it. One percent (1%) is just $10 out of every $1,000 you make. Odds are that you will not miss that cash now, but future you will be glad to have it plus all of the compound interest it will earn.
If you do not have the option of an employer based retirement fund, I suggest opening a Roth IRA with a low fee brokerage firm and automating your contributions for the day after your paycheck arrives. As soon as the money is deposited, it’s out of sight until you need it in the future.
Wrap It Up!
For every $100 you start investing each month, you will have just over $100,000 in 30 years. Taking advantage of the gap in spending and earnings many have in their early careers and using it to front load your retirement will set you up for success down the road with little effort. If this option is available to you, take it and run with it. You will not regret it.
Have you started saving for retirement in your 20’s? Let me know in the comments below!