The Most Important Money You Save
This year, I will turn 30. Sometimes I feel like 21 was just yesterday. Other days I try staying up past 9:30 and am immediately reminded that I am definitely knocking on the door of 30. Being the sentimental person that I am, I’ve spent a lot of time the past few months thinking about my 20s. They were truly incredible. I was recently asked, if I could give one piece of advice to all the 20-year-olds out there, what it would be. Now, this particular person was asking on a personal level, and that’s how I answered, but then I thought about how I would answer professionally.
I wish I’d saved more earlier. In one of my previous posts about debt, I talked about my personal struggle with controlling my finances in my early 20s. Fresh out of college and making real money for the first time, I did what most young people do, I spent. Fortunately, I got it under control before it became a real problem, but it’s painful looking back and thinking about what that money would be worth today had I saved (and invested) it rather than spent it.
Alright, it’s about to get nerdy up in here, so bear with me. There is a calculation that we use in the industry called the time value of money. It shows the power that time has when it comes to growing our money. The calculation is as follows:
FV= PV x [1 + (i / n)]^(n x t)
FV stands for future value and PV stands for present value. The interest rate is represented by i (this may also be referred to as the rate of return); n represents the compounding periods per year (often times this is just 1) and t is the number of years. While that equation can seem daunting, if we break it down into real numbers it is a lot less complex. Let’s assume i (the rate of return) is 6% and it compounds annually (n=1). For the sake of this example let’s assume we leave this money invested for a period of 40 years (beginning at 20 and ending at 60 for example). As a present value, we will assume for your 20th birthday you were gifted $1,000 and elected to invest it all. Here is our new equation:
FV= 1,000 x [1 + (.06/1)]^(1 x 40)
FV= 1,000 x [1.06]^40
Significantly more manageable, right?! This gives us a future value of $10,285. Your one-time investment of $1,000 on your 20th birthday at an annual rate of 6% is worth over $10,000 on your 60th birthday. Now, here’s were it gets crazy. Let’s assume you didn’t save that $1,000 on your 20th birthday and on your 40th birthday you wake up filled with regret, wishing you had saved 20 years ago. You decide you are going to now invest whatever it takes to get you to that $10,285 by your 60th birthday. Assuming the same rate of return, we get an equation that looks like this:
$10,285=PV x [1 + (.06/1)]^(1 x 20)
$10,285= PV x [1.06]^20
Some quick calculator skills give us a present value of $3,206. That means 40-year-old you needs to save more than three times what you would have to save at 20. Ouch! That is the time value of money.
That’s a very simple example with a one-time investment. Of course, that isn’t typically how people save. Normally we save little by little over time. Rather than boring you with another equation, I’ll just line out the scenario.
You are 20 years old, have started your first job, and decide you are going to contribute and invest $200 per month in your company retirement plan. For simplicity purposes we will say you get an annual rate of return of 5% and you continue this saving/investing routine for 40 years. At 60 years old, your $200/month will be worth $297,771. Over that 40-year period, you contributed $96,000. If you chose to wait until you were 40 to start saving, even if you elected to save $400/month rather than $200, you would only have $163,015.15. You would have contributed the same $96,000 either way.
Is anyone still there? Did I lose everyone? I know that is a lot of technical talk, but I hope it drives home this point, the money you save in your 20s is so much more valuable than the money you save in your 30s, 40s and 50s. Now, if you are like most 20-somethings, you are likely caught up at the idea of having an extra $200 per month to set aside and save. It sounds like a lot. So maybe $200 isn’t your number, maybe it’s $50. That amount is not what is important here, the time is. If you could do one thing for your future self, let is be that you save early. The cost of waiting is so high, often times too high for most people to make up. The money you save early is easily the most important money you’ll ever save!
All opinions expressed are those of Molly VanBinsbergen and not necessarily those of Raymond James. Any information is not a complete summary or statement of all available data necessary for making an investment decision and does not constitute a recommendation. Investing involves risk and you may incur a profit or loss regardless of strategy selected.
This is a hypothetical example for illustration purpose only and does not represent an actual investment.
