You’ve just started collecting your first few paychecks or you are a more seasoned 3rd or 4th-year resident. Either way, you may be thinking, 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. Its only 50 dollars- Does it really matter if I save it or spend it on dinner, drinks, and/or movies? Well, if you have that thought process month after month, you will seriously damage to 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 years old. That gives you somewhere around 45 years of a 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 the time of retirement. Of course, some of that money would be eroded by inflation.
Now let’s assume inflation is going to run 2.5%. That means that the 1596 dollars would be eroded by inflation and would 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 that you spend you are really using 525 dollars in “future money” when you are 70 years old. Is that meal with drinks worth 525 dollars?
Let’s think about these calculations a little bit deeper. Say you decide to put away those 50 dollars each month for your full first year of work. That would be 50 x 12 or 600 dollars saved for this year when you are 26 years old. 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 (at peak earnings age) at 50 dollars per month? It would be the following calculation for 7 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 8 years
In other words, you would need to save for 7-8 years at 50 dollars per month when you are 50 years old to come up with an approximate total of 6,300 dollars of future money. This compares to the spry age of 26 when you only need to save 50 dollars for one year in order to come up with the same amount at 70 years old.
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 10 times as many dollars, but each dollar earned will be 7-8 times less powerful. This is a good reason alone to start investing today.
Another Reason Why Investing is So Important Now- Low Prevailing Interest Rates
It turns out that interest rates are very low in the year 2016. And, there is no guarantee that interest rates are going to return to the high single digits or above for a very long time. So in retirement, you need a significantly larger nest egg than you would have needed 10, 20, or 30 years ago. Today, you can get a maximum “safe” interest rate of 3% on instruments such as municipal bonds. And the 30-year treasury bond, another safe investment, yields only 2.5%. So, if you want a guaranteed income when you get older, you may need to save twice or three times as much as many years ago when the same interest rates would have been 6,7 percent or more.
Think of it this way- today you have a million dollars, you only collect 25-30 thousand dollars per year. 30 years ago with that same million dollars collecting interest at 10 percent, you would have had a hundred thousand dollars per year. That’s a really significant difference in the potential quality of retirement. It behooves all of us in the year 2016 to become really 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, take a shower, etc. If you don’t develop those habits at an early age, it may never become part of your routine. I would say that the same idea goes for putting away investment money on a monthly basis.
Those radiology residents that don’t start investing on a monthly basis early in their career are much less likely to do the same when they are further on in their career. 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 all can’t work forever!!! Who knows how much will be left in the Social Security trust fund by the time 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, it will become a habit to invest monthly for the rest of your life and you will feel comfortable doing so. It’s not just 50 dollars per month or 600 dollars per year. It’s a nice gift of 6300 dollars per year for your 70-year-old birthday and it’s 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!!!
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