Compounding and the Cost of Waiting
- Small amounts saved early in life can outpace more substantial savings later on.
- The power of compounding generally works best the longer the window for potential growth.
It's important to start early when saving for retirement
One of the best ways to make your money work harder for you is to start saving now.
The power of time
The sooner you begin saving, the better your chance of reaching your goals.
Why is time of the essence? The sooner you begin saving – even small amounts – the better your chance of reaching your retirement goals. Consider the following example that shows how much waiting to invest can cost.
Putting time on your side
Let's assume hypothetical Investor A invested $1,000 per year for 10 years, beginning at age 30 and reinvested his returns (interest, dividends, capital gains) back into his account. Investor B invested the same amount per year, earned an identical rate of return, and reinvested her returns; however, she waited until age 45 to start with the strategy and continued with it for twice as long (20 years). Even though Investor A saved less money – half as much as investor B – Investor A had more money at the time of retirement, all because of starting earlier.
What’s the secret?
The extra years of compounding are what boosted Investor A’s bottom line. Investor B will now have to save considerably more if she wants to catch up. This is the potential cost of waiting, a cost that quickly adds up. It doesn’t matter what age you are – you'll have more time on your side if you start saving for retirement today.
What you can do next
A few simple steps can help you along the road to retirement savings.
- Talk with your Financial Advisor about how much you should be saving for retirement.
- Use a savings calculator to see compounding in action and how little changes to your spending can have a big impact on how much you can save for retirement.
- Commit to increasing your ongoing contributions to your IRA or 401(k), at least to the maximum of your employer’s match (if any).
- Avoid taking loans from your 401(k) if possible to keep focused upon your long-term needs.
- If you change jobs, understand your retirement distribution options and the full cost of cashing out.
- Consider opening an IRA if you’re already maxing out your employer-sponsored plan contributions for an additional tax-advantaged savings opportunity, or if you don’t have access to an employer plan. If you’re self-employed, consider establishing a Simplified Employee Pension (SEP), SIMPLE IRA, or other plan with similar tax advantages.
- Start saving for retirement as early as possible.
- Ask your Financial Advisor about tax-advantaged accounts.
- Use some calculators to start getting an idea about how much you should save.
Wells Fargo Advisors does not provide tax or legal advice.