One big mistake that many young people make is that they don’t start saving early. As a result, they end up paying for it later on in life. When most people are young, they’re not really concerned about what’s going to happen 40 years from now. They’re not concerned about paying for retirement or paying for their kids’ educations. That is a huge mistake! Additional time in the market is necessary for your nest egg to compound.
My parents always emphasized the importance of saving money. They were immigrants who came to this country with almost nothing. They met here in the US and took advantage of all the opportunities, freedoms, and resources that this country had to offer. Through time, discipline, and foresight, they managed to build a nest egg, raise 3 kids, and pay for their educations. The 3 of us even wanted to go to private colleges, which created an even heavier burden on them. I am forever grateful for the opportunities that I was given which they didn't have growing up. Seeing them go through all that has helped me understand the importance of getting started with building my nest egg early.
Here are four scenarios to illustrate my point. Suppose you have four people who start saving and contributing to their 401K retirement portfolios at different times in their lives. The ones who start saving later contribute a larger amount each year.
Each one of these people end up with approximately $1.3M at age 65 for retirement. However, the person who started saving at 22 only had to invest $5,000 per year whereas the person who started saving at age 39 had to invest $18,000 a year. In fact, the 39 year old would have contributed more than double the amount over his lifetime ($486K vs $220K) just to end up with a similarly sized portfolio. Even a six year head start (22 vs 28) will lead to $65,000 less in overall contribution necessary to achieve $1.3M. Compounding is certainly a very powerful force. Here are the growth trajectories of their respective portfolios.
Maxing Out 401K
So, what happens if you start maxing out your 401K ($18,000 contribution limit as of today) starting at age 22? Assuming no company match, a 7% annual return will yield the following at age 65:
You would have more than $4.7M after contributing $792,000 over the course of your career! By most definitions, that would be considered wealthy. Of course, most people start off with student loans or don’t make enough to be able to comfortably max out their 401Ks starting at age 22. However, my point remains the same--giving yourself adequate time in the market can do wonders for your portfolio.
Always remember to keep your eye on the big picture. You may not need $4.7M for retirement. You may only need $1.5M. It depends on your expenses, expectations, and standard of living. The key is to have a plan and stick to it. Regardless, it always help to start saving early if you want to achieve your financial goals.
Another thing to note is that the current maximum 401K contribution amount is $18,000. After you have saved about $300,000, your annual rate of return will be about the same as that maximum contribution. After this point, your portfolio will quickly snowball and increase in size even if you are not contributing the maximum.
There are many retirement plans that you can use to start saving and various ways to build wealth. The important thing is to DO SOMETHING even if it is just a little bit. The earlier you start, the better off you'll be.
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