Disciplining yourself to save at a young age is a challenge; you’re likely earning a modest income and yet you’re faced with big expenses like college loans, weddings, house down payments, and the like. Saving for your golden years may seem like a lot less of a priority than dealing with present concerns and you’re probably telling yourself that you’ll make up for it down the road by saving more.
But here’s the rub … if you don’t start investing early, you’re going to have to put a lot more into investments to make up for the missed opportunity of saving and investing in your younger years. Why? The power of compounding.
In a nutshell, compounding refers to the phenomenon by which the earnings that you make on your savings, or investments, are in turn able to generate their own earnings for your portfolio. The longer your investment horizon, the more you are able to reap the benefits of compounding because your returns on your investments will perpetually create their own returns. The concept may be best illustrated with an example…
After starting his first job at the age of 23, Ryan wanted to start investing early and set aside $500 a month to invest, or $6,000 each year. He puts those funds into a brokerage account which invests in diversified index funds. Five years in, Ryan tells his brother, Hunter, what he’s been doing. Hunter, who is two years older and has a higher paying job, but no investments decides that he is going to try his hand at this investing thing. Always a competitor, he decides he will double his brother’s goal and save $1,000 a month, while Ryan continues his $500 monthly contributions.
After 5 years of contributing $1,000 a month, the brothers compare their results. Hunter fully expects to be nearly caught up with his brother; after all, he’s effectively set aside the same amount of money by doubling his brother’s contributions, right? Wrong. While they earned the same return (8%), Ryan has a balance of over $94,000 while Hunter’s balance is just over $73,000. Why a $21,000 difference? The difference can be attributed to compounding – Ryan’s money simply had more time to grow, and then the growth on his investments had more time to grow even more.
Now that we’ve (hopefully) convinced you that investing early is the way to go, let’s tackle some of the misconceptions about investing that are out there. One of the biggest is that you need to have a significant sum saved up to be able to invest. Not so! In fact, it has never been easier for smaller investors to get into the game. Several banks offer brokerage accounts no minimum balance requirements. Another misconception is that you need to either be an investment banker or have some high-flying (and high priced) financial advisor to know which investments to put your money into. Also false! There are plenty of low-cost and well diversified mutual funds and electronically-traded funds (ETFs) available, where the experts have already selected and bundled investments based on your personal risk tolerance.
When it comes to investing, time definitely equals money. Start early and be consistent in your contributions to investment accounts. It pays to have time on your side!