You’ve just started collecting your first few paychecks or are a more seasoned 3rd or 4th-year resident. Either way, you may think, I only have 50 dollars left over at the end of the month after paying off student loan interest, putting money into an emergency account, and paying off all my expenses. It’s only 50 dollars- Does it matter if I save it or spend it on dinner, drinks, or movies? If you have that thought process month after month, you will seriously damage your future retirement net worth. Let’s run through some calculations.
The Basics of Compounding at Different Ages
Compounding at 26 years old
So let’s assume you are beginning residency and you are 26 years old. And let’s say you will also be working until you are 70. That gives you somewhere around 45 years of working life. Let’s estimate that you can average 8 percent per year in your investments (the stock market has given back close to 10 percent returns over the past century!) So based on the 8% yearly return, your 50 dollars would be worth (50*1.08^45) or 1596 dollars at retirement. Of course, some of that money would erode due to inflation.
Now let’s assume inflation is going to run at 2.5%. That means that the 1596 dollars would erode from inflation and be worth (1596/1.025^45) or the equivalent of 525 dollars in today’s dollars after inflation. So, think about it… For every 50 dollars you spend, you use 525 dollars in “future money” when you are 70 years old. Do you believe that a meal with drinks is worth 525 dollars?
Let’s think about these calculations a little bit deeper. Say you put away those 50 dollars each month for your entire first year of work. That would be 50 x 12 or 600 dollars saved for this year when you are 26. Or, approximately 6,300 “future 70-year-old you” dollars saved (525 dollars x 12) after inflation.
Compounding at 50 years old
How long would it take to save the same amount of money at 50 years old (peak earnings age) at 50 dollars per month? It would be the following calculation for seven years of savings:
600+ (600*1.08/1.025)+ (600*1.08^2/1.025^2)+(600*1.08^3/1.025^3)+ (600*1.08^4/1.025^4) + (600*1.08^5/1.025^5) +(600*1.08^6/1.025^6) +(600*1.08^7/1.025^7) or 5823 dollars after 7 years.
If you add another year of saving at 50 dollars per month, you come up with an additional (600*1.08^8/1.025^8) for a total of 6734 dollars at eight years.
In other words, you would need to save for 7-8 years at 50 dollars per month when you are 50 to come up with an approximate total of 6,300 dollars of future money. This total compares to the spry age of 26 when you only need to save 50 dollars for one year to come up with the same amount at 70.
What does this all mean for you?
So, the bottom line is that even though you will be making a lot more in the future, your future dollars are nowhere near as powerful as today’s dollars. You may be making ten times as many dollars, but each dollar earned will be 7-8 times less potent. This power of compounding is a good reason alone to start investing today.
Another Reason Why Investing is So Important Now- Moderate Prevailing Interest Rates
It turns out that interest rates have significantly improved in the year 2023. But, there is no guarantee that interest rates will return to 8,9 percent or higher for a very long time. So in retirement, you need a significantly larger nest egg than you would have required 30 or more years ago when interest rates were at that level. Today, you can get a maximum “safe” interest rate of 4.5-5% on instruments such as municipal bonds. And the 30-year treasury bond, another safe investment, yields close to 4%. So, if you want a guaranteed income when you get older, you may need to save twice or three times as many years ago when the same interest rates would have been 8,9 percent or more.
Think of it this way- today, you have a million dollars, and you only collect 40 thousand dollars annually. Thirty years ago, with that same million dollars collecting interest at 10 percent, you would have had a hundred thousand dollars yearly. That’s a significant difference in the potential quality of retirement. It behooves all of us in 2023 to become conscientious savers/investors.
The Importance of Basic Investing Habits for Retirement
I would also argue that, as human beings, we tend to do many things habitually. We brush our teeth, go to work, shower, etc. If you don’t develop those habits early, they may never become part of your routine. I would say the same idea goes for putting away monthly investment money.
Those radiology residents who don’t start investing every month early in their career are much less likely to do the same when they are further on. You are likely to want to spend without thinking about the possibility of your future if it is not a habit. Also, you need to develop a comfort level with how to invest. If you don’t start, you will not know the basics and be less likely to contribute. And most importantly, believe it or not. We can’t work forever!!! Who knows how much the Social Security trust fund will leave you when you retire?
What’s the Upshot?
So, the crucial factors of compounding and low prevailing interest rates are important reasons to start saving that extra 50 dollars or whatever you have at the end of the month in an investment account. Start making a concerted effort to plug away at your retirement account. Eventually, investing monthly for the rest of your life will become a habit, and you will feel comfortable doing so. It’s not just 50 dollars per month or 600 dollars per year. It’s a lovely gift of 6300 dollars yearly for your 70-year-old birthday, not just chump change. For your sake and for your retirement’s sake, start putting away money for investment, no matter how small, right now!!!
If you have any comments or questions, please reply below.
