One of the biggest sentiments I encounter when chatting about retirement savings with others goes a little something like this,
Ahhh. I’m young – I’ve got plenty of time to save for retirement in my later years, when I’m making more money. Might as well live it up while I’m young!
To some extent, I get it. I really do. Health and youth are in finite, limited quantities and should be cherished (although 60 is the new 40, or something like that).
Unfortunately, when those later years come around, the savings don’t follow as promised by younger versions of ourselves. For starters, those who have made their identity over decades through spending have a rough time making the transition to an identity as a saver. The longer you’ve identified as a spender, the more difficult it is to break free – as with any addiction.
Secondly, the “making more” assumption is an important detail that often does not become reality. Almost 100% of lifetime earnings gains come in the first decade of your career:
For the median lifetime earnings group, average earnings growth from ages 35 to 55 is zero. Second, with the exception of those in the top 10% of the LE (lifetime earnings) distribution, all groups experience negative growth from ages 45 to 55.
So, there’s that depressing statistic.
Aside from all that, there is one extremely compelling reason above all else that illustrates why you should not hesitate to start saving – the power of compound returns. Here’s a chart from JP Morgan to help illustrate:
Starting savings 10 years earlier (at age 25) can literally more than double your nest egg by age 65 versus starting at age 35 ($1.87M vs. $919K). In other words, 10 years sooner equates to 2X the savings. And that’s with a conservative annual earnings estimate of 6.5% and modest annual savings of $10K.
For longtime readers, this shouldn’t be news. The power of compound returns is crazy effective:
$1 saved in your twenties can be the equivalent of $10 saved in your fifties, if invested over time… Actually, $10.06 to be exact – at an average annual rate of return of 8% on your investments over 30 years. Even if you factor in 2% annual inflation, you’d have 556% of the buying power for every dollar you save today.
The millennial personal savings rate is -2%. You can talk about the virtues of youth excess all you want, but if you don’t save in your twenties, you’re screwing your future self. Work is a temporary opportunity, so save what you can while you can.
If you save early and often enough, you can hit your crossover point and financial independence early enough that you can have both savings and your youth to play with, for decades to come.
There is an increasing amount of research and evidence that has found that material possessions don’t lead to sustained happiness (on the flip side, financial security does).
Bottom line: using “youth” as an excuse to put off savings is a really poor excuse that doesn’t really help you now and can lead to catastrophe later on.
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Great point. There’s no replacement for saving more… and saving it sooner than later.
Many years ago, for those working in companies with pensions and good salaries, retirement funding was explained as the three legged stool.
1) Social Security
2) Company Pension
3) Personal savings for retirement
The first, Social Security, is such that the higher the wage, the more that will be returned at retirement. Wages have dropped, relative to inflation, over time for much of the population. So the expected benefit is diminished.
The second, Company Pension, is becoming extinct and replaced by 401K’s. The most significant point about pensions is that they started to build up credits as soon as work began. The only way that 401K’s can start to replace that leg of the stool is to match the behavior. Contribute the max as soon as work starts.
The third leg, personal savings was often started later in life. After paying off the house and the kids finishing college, the outlay of money would go way down and there would be plenty for savings. This technique worked because with higher wages, Social Security was a more substantial retirement income source. This technique worked because the pension was accumulating, and at a higher rate than most company’s matching for 401K’s. This technique worked because with higher wages, people were able to get to the point of everything paid for with no remaining debt and much more available funds for savings.
If someone wants to have a retirement that starts to approach what would have existed years ago, the first step is to max out the retirement savings from day one. With a 401K or equivlent, and if none exists max out the Roth IRA and then some more savings equivalent to what would be a max 401K (including what a company would contribute). If they want a retirement equal to what they would have had before, they have to save even more.
There is the other aspect of preparing for retirement. If someone works for themselves (owns their own business), then if possible, don’t rent the building that your business is in. Own the building. The costs may be higher up front compared to renting, but over time the costs become less than renting and eventually the costs drop drastically when the last mortgage payment is made. Once the building is paid off, there is more profit for putting away for retirement and at retirement selling or renting the building is somewhat like having a pension.
It’s not out of the realm of possibility that social security won’t exist by the time today’s twenty and thirtysomethings retire. I doubt that’ll happen since touching it is politically toxic, and politicians put their reelection chances ahead of being helpful, but it’s gradually becoming more fiscally insolvent and an increasing part of our deficit. Eventually, we may need to bite the bullet and do what must be done, as unpopular as it would be.
Although pensions are rarer, they still exist. But they aren’t as safe as they seem either. Take a look at what happened to Detroit’s pension holders – the city needed to cut costs and drastically reduced the pensions. Now the people who relied on them are screwed if they didn’t put enough money away.
If you can afford to do so, I think it’s crucial that you invest enough money outside of your theoretical Social Security and pension payouts to self-fund retirement. If your social security/pension ends up still being there when you’re ready to retire, great! You have even more money, certainly nothing to complain about. But if not, you’ll be very, very happy that you prepared for the worst…
Totally agree with this comment. We have to do everything in our own power and if there is SS or pension then great.
Great illustration. Seems most good things come to those who are able to delay gratification. And you don’t even have to give up too much if you start early enough. That $10,000 a year which will grow to almost 2 million is just over $800 a month. That’s very doable for most Americans and can come right out of your paycheck via a 401k deduction.
Another issue is that people are all or nothing when it comes to wealth. Either they just resign themselves to a minimum wage existence or they think they have to create the next Facebook. Taking the middle path and saving a little bit consistently is a nearly guaranteed path to financial independence.
Get the power of compounding started as early as possible for every reason you point out. The younger the better and the benefits are exponential. Great point to re-inforce and continue to hammer into the minds of fellow millenials.
Bert, One of the Dividend Diplomats
Amen. Recently turned 35 and looking at ~$325k in my 401k. A long ways to go but doing the math if i keep saving in my 401k alone should be well on my way to a secure retirement.
Umm… i’m 36 and have $105k in my 401k and I thought I was doing well. Alex, my friend, you’re crushing it. That’s gotta trend out to well over 2-3 million in 30+ years from now.