Saturday, February 6, 2010

Save Early

Tip #229 - Save Early. The earlier you save the more you will have just because of the power of time or the “time value of money” as it is often called in financial circles. When you put money away today, it accumulates interest, and the interest accumulates interest, and that interest accumulates interest, so the power that your money has today is quite great. Alternatively, if you wait to save money, it has little power because there is not time for the interest to grow on your money.

Let’s look at some examples to highlight this concept better. Suppose you just had a baby and want to pay for his college costs when he turns 18. It’s very easy to say, “Gee, that’s a long ways away. I have time to save for that. Why start now?” I’ll show you why. Let’s say you put $100 away in a savings account each month from when your child is born until he turns 18. Assume you can get an interest rate of 5 percent. Guess how much money you’d have toward your child’s tuition when he turns 18? Almost $35,000! For just putting away $100 per month.

Now suppose you don’t get serious about your child’s tuition until he’s enters high school at age 14. This is probably when most people start thinking about how they are going to pay for college because they suddenly realize they haven’t saved a dime because it was so “far off.” How much do you need to put away monthly when your child is 14 to save $35,000 by the time your child turns 18? Over $600 per month! Coming up with $600 per month, even for a short period of time, is going to be pretty difficult. Compare that with $100 per month that can probably be saved by cutting back on small things at most any time in your life.

If you can get higher interest rates, the more magnified the advantages are for putting away money early. Remember, interest rates on savings accounts haven’t always been as low as they are today, and they won’t continue to be 1% forever. Using the same example above, if your money could get 10% interest, you would have $60,000 after 18 years of saving $100 per month, while waiting until your child is 14 would require you to put away over $1,000 per month to get that same $60,000!

Also, the longer the timeline, the more magnified the benefit of early savings is. For example, if you are saving for retirement, and start putting away $100 per month at age 20 and earn 5% interest on the money, you would have over $200,000 by the time you are 65 years old. If you wait until you are 50 to start saving for retirement, you would need to put away $750 per month to get to that same $200,000.

The problem some people have when they are young is that they think they will be making more money in the future or that it will be easier in the future to save money so they don’t bother saving. But in reality, there are always big expenses – when you’re young there are your own education expenses. Then as you get older there are rent expenses, then new home expenses and baby expenses. Then as kids grow up there are expenses for braces, activities, and schooling. As they get even older, there are your own medical expenses. There is no one time in our lives when we won’t be without expenses, so the best way to say money is to just start putting money away, as early as possible, no matter how small the amount is. It’s much easier than to all of a sudden having to put away large amounts because you didn’t start saving earlier. An added benefit is that once you get in the habit of putting money away on a monthly basis, it becomes second nature – just like paying your cell phone bill. So why not start putting away money today? It will help you a lot down the road!

In Real Life (IRL) – My husband and I have not done anything extraordinary to have accumulated a few hundred thousand dollars in our retirement accounts. And I did absolutely nothing special to have saved up $70,000 to put down on my first home ten years ago. I didn’t strike it rich on the lottery, invent the next Post-it Note, or inherit a huge sum from a long-lost uncle. I simple started putting a couple hundred dollars away per month when I started my first job at age 21. I then expanded it to put away a few hundred dollars per month into my retirement account, as well. As I got raises, I gradually increased my regular monthly savings to be $500 per month. It became just one of my “expenses” that I paid each month. I mailed off the rent check to my landlord at the same time I mailed off my savings check to my mutual fund.

Then 10 years later, I found I had $70,000 for a down payment on a house. It was as simple of that. By not waiting until a few years before I needed the money to start saving, I was able to take advantage of the time value of money (and of course the fabulous stock gains that I was getting in the early 1990s!) I didn’t wake up one day when I was 40 and say, “I need to start saving for retirement.” I just did it back when I was in my 20’s when I thought I didn’t need to. That simple act alone is the primary reason that we are financially comfortable today.

If you didn’t start putting money away when you were young, then get into the habit today. You can’t get your earlier years back, but you get on the right track by starting to put money away today – whether it be toward a new home, your retirement, or your child’s college fund. No matter how small that amount may be, it’s a good start to getting you in the habit of saving each month. And as you see it grow, you will find ways to increase your monthly contribution. As the saying goes, “no better time than the present.” It’s the earliest and best time you can start saving.

***I used the calculators at Bankrate to come up with my savings calculations.

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