What do you think will give you a larger portfolio value at 65: saving $12,000 pa for 10 years or $12,000 pa for 20 years?
Believe it or not, saving for 10 years is the answer – only if those 10 years are at the early stages of your working life. An investor saving from the age of 35 for only 10 years (to 45) will end up with a larger portfolio balance at 65 when compared to an investor saving from the age of 45 until 65.
How is this even possible? Enter compound interest – earning interest on your principle balance then earning interest on interest, creates a snow ball effect until you’ve got a runaway train working in your favour. In fact, in those 10 extra years, the portfolio’s interest on interest is so great that it feeds on itself to a point where even two decades of regular contributions are unable to yield superior results.
Let’s take a look at an example:
James saves $12,000 pa from age 35 to 45. At age 45, James stops contributing to his portfolio and simply let’s his portfolio grow organically until he reaches age 65. Jenny on the other hand, saves $12,000 pa from age 45 to 65. Both James and Jenny’s portfolios grow at an annualised rate of 7%.
Here are the results:
As you can see from the above chart, James’ portfolio is worth $732,902.59, and Jenny’s portfolio is worth $538,382.12. Even though James only saved for 10 years, his portfolio is worth over 36% more than Jenny’s.
“Someone is sitting in the shade today because someone planted a tree a long time ago.” – Warren Buffett
The common feedback I hear when speaking to clients and investors, is that they wish they started saving earlier. Yet investors are forever playing catch up because they failed to plan ahead. To highlight how powerful compound interest is, and the impact it can have on your future life, I ran some more numbers:
Jenny saves $12,000 pa from age 35, and she does so until she reaches age 65. Her portfolio returns a conservative 7% pa. James on the other hand, decides to start saving at age 55, however, he doubles Jenny’s savings rate and saves $24,000 pa. He also decides to invest in riskier assets, and his portfolio generates double the return of Jenny’s, at 14% pa.
Here’s the chart:
Even though James doubles his saving and returns, his portfolio is dwarfed by that of Jenny’s. In fact, Jenny’s portfolio is worth over 120% more than James’.
They say there’s never a perfect time to have kids, I guess the same applies to saving for your future. The snowball effect that compound interest has, in my opinion, is completely underestimated by most people. The longer you go without putting in place a game plan, the more money you’re going to have to forego, and risk you’re going to have to take on just to play catch up. And if things go wrong at precisely the wrong time, just as they did for many retirees during the GFC, it’s going to blow your balance sheet to smithereens.
The point is, there is no amount too small to start investing so that you have a huge advantage in the years to come. Take the unfair advantage and get rich slow.
*Blog originally published by Robert Baharian, Founder @ Baharian Wealth Management.