During my first professional job at San Diego State University, I went to a meeting sponsored by the human resources department explaining the 403(b) retirement plan. It’s like a 401(k), except designed for educational institutions. The speaker explained that I could have a percent of my salary transferred into a retirement account and that I wouldn’t pay income tax on any money I diverted into the account.
I figured that it could save me $240 for every $1,000 I invested at my 24% tax rate.
Even better, there would be no tax on the money, the dividends or capital gains, as long as the money remained in the retirement account.
This was unbelievable!
And if that wasn’t enough of a draw, the speaker said that my employer would match my contribution up to 5% of my salary and I could invest that money as well. The beauty of this was that the money was mine to keep.
I thought I was dreaming!
The human resources representative explained that the law allowed a maximum savings of $15,500 per year in this account (in 2020 the maximum contribution amount is $19,500 per year) and it could grow and compound for years, without paying any taxes until the money was withdrawn in retirement.
I walked out of the meeting with my head swimming. There were charts and graphs of the potential wealth I could accrue over the years and the idea that a small – okay not really that small – sacrifice today could lead to spectacular wealth for my retirement.
This article will explain three reasons why you should consider investing now, and how small financial behaviors today can lead to extraordinary wealth for your later years. And the beauty is that you don’t need to earn a tremendous amount of money to start investing now.
1. You should consider investing now to enjoy compound returns.
Albert Einstein is quoted as saying that “Compound interest is the eighth wonder of the world. He who understands it, earns it and he who doesn’t pays it.”
Once you understand how compound returns can grow your investment dollars, it’s easier to choose saving and investing today, overspending.
The concept of compounding works like this:
Invest $5,000 in year one and earn 7% return and at year end, your account is worth $5,350.
In year two, your $5,350 investment grows to $5,724.50.
In year three, the $5,724.50 investment grows to $6,125.22
In year four the $6,125.22 investment grows to $6,554.00
By the end of year five your original $5,000 is worth $7,012.76
This example assumes that your investments earn 7% each year.
This is the beauty of compounding. Your money is making more money and each additional amount is added to the original balance and continues to grow.
Now, imagine that you begin saving in your workplace 401(k) retirement account or 403(b) at age 30 and your employer matches your contribution with free money. As your income grows, you decide to increase your contributions. The compounding of your investments is mind boggling.
This retirement account calculator shows that by contributing just 10% of your income each year, with a 5% employer match, at age 65 you’ll amass $1,529,583.
The analysis assumes:
- Your current salary is $60,000
- You contribute and invest 10% of your income
- Your salary increases 3% per year
- Your employer adds 5% of your salary annually
- Your average annual rate of return is 7%
- You invest for 35 years
2. You should consider investing now, because you need to invest less money to enjoy a greater payoff.
Imagine two investors start investing at different times. One invests less than the other and ends up with more money in retirement.
That’s the second reason to start investing now. If you start investing earlier it’s easier to amass more money through compounding.
Cathleen, age 30, has a great job and is motivated to invest for retirement immediately. She earns $85,000 per year and decides to invest $19,000 per year in her 401(k) account, the maximum amount the law allows. Cathleen’s employer also contributes 5% of Cathleen’s salary or $4,250 per year. This amounts to $23,250 invested every year. She earns an average 7% annually and invests in a 70% stock and 30% bond allocation.
At age 40, Cathleen’s retirement account is worth $337,308. Not bad for 10 years investing!
She stops investing at age 40 and leaves the balance in the account as it continues to grow at 7% annually. She doesn’t add any additional money to the account after age 40.
Cathleen invested a total of $232,500 for retirement, including her employer’s contributions.
When Cathleen turns 65 years old, the $232,500 that was invested is worth $1,830,700, without adding any additional funds after age 40.
Kris wasn’t as savvy as Cathleen. He didn’t begin investing in his 401(k) until age 40.
At age 40 Kris invests the exact same amount per year as Kathleen did and his employer also invests the identical amount for a total of $23,250 per year. His investments also average a 7% annual return.
Kris continued to invest the exact same amount for the next 25 years, 15 years longer than Cathleen, for a total investment amount of $581,250, including the employer contributions.
At age 65, Kris’ account is worth $1,578,700. Now, this is a great amount of money, but, let’s compare Kris’ total investment with that of Cathleen.
Cathleen and her employer invested $232,500 and ended up with $1,830,700 at retirement.
Kris and his employer invest $581,250, more than double the amount that Kathleen invests, and ended up with $1,578,700, roughly a quarter of a million dollars less than Kathleen.
And that’s the second reason to start investing now.
By starting to invest earlier, you can amass greater wealth with a smaller investment amount.
Assumptions: Cathleen and her employer invested $23,250 per year from age 30 to age 40. Kris and his employer invested $23,250 per year from age 40 to age 65. Each earned an average annual return of 7%. No adjustments were made for taxes or inflation.
3. You should start investing now so that you have a better chance of reaching your financial goals.
Investing isn’t only to amass money for retirement, although that’s an important goal. Investing is one of the best ways to build up cash for any goal that is intermediate-term or occurs in seven years or more. These intermediate term goals might include, funding a child’s education, buying a home, taking a special vacation, or buying a car with cash.
If you keep your money in a bank account or certificate of deposit, you’ll earn low single digit returns. While, the investment markets have averaged much greater returns over long periods of time. With greater returns over time, you’ll be more likely to reach your financial goals.
The reason investing is ideal for intermediate or longer term goals is because in the short term, the financial markets are volatile. While, over the long term, they have been shown to grow your wealth more rapidly than a savings account.
The smartest investors understand, that since money in your retirement account needs to stay put until you’re at least 59 ½, or you’ll pay a penalty for withdrawals, it’s a good idea to invest in a taxable account, too. This might be an investment account at a major broker like Fidelity, Schwab or eTrade. Or you might choose to invest with an app like Robinhood or M1 Finance.
In fact, some intermediate term goals, that you might have thought were out of reach, could be achievable by starting to invest now.
3 Reasons to Invest Now – Wrap up
The simplest reason to invest now is because your money grows exponentially, the longer it compounds. So the earlier you begin investing, the easier it is to amass a large retirement stash or money for mid-term goals.
Whether you start investing with $100 per month or $1,000, the most important reason to invest now is to develop the saving and investing habit. It’ll make your future richer and your financial worries fewer.
Disclaimer; The information is provided for discussion purposes only and should not be considered as advice for your investments. Investing involves risk. Your investments are subject to loss of principal and are not guaranteed.
About the Author:
Barbara A. Friedberg, MBA, MS is a veteran portfolio manager, expert investor, and former university finance instructor. She is author of Personal Finance; An Encyclopedia of Modern Money Management and several other books. Friedberg’s websites include Robo-Advisor Pros.com and Barbara Friedberg Personal Finance.com.
Published on January 7, 2020