The Power of Compounding

Often times in life we’re faced with decisions that pit us between choosing fun today or the not so exciting alternative of tomorrow. Like choosing between socializing with friends versus the never-ending list of yard work to be done every weekend.

Choosing can be difficult, except afterwards when hindsight is 20/20. You may find yourself going through the “shoulda, coulda, woulda” thought process, wishing you’d have chosen the yard work. The consequences of that example situation are arguably minor, however, that’s not the case for everything.

The one space you hope not to play that “it’s too late” mental game with is saving for retirement. All too often, folks put off saving today for tomorrow because retirement seems like an eternity away. Sadly, time catches up with people faster than they ever anticipated due to today’s accumulating expenses always trumping tomorrow’s goals. The kid’s travel sports gear, unforeseen medical expenses, career uncertainty, the list goes on.

Saving even the smallest amount early on makes a huge impact. For instance, take the example in the table below. Each of these individuals saves for 10 years and earns an assumed annual return of 5%

As the table depicts, the power of compounding has a huge effect! The 21-year-old contributes only $80,000 in comparison to the 51-year-old who must save more than $340,000 to breakeven at age 65.

This is a rather simplistic model that makes several assumptions about risk tolerance, risk capacity, and market risk and sequencing. Risk tolerance is the measure of a person’s ability to emotionally handle market risk, while risk capacity is the measure of market risk that the person can financially weather. For example, the 21-year-old and 51-year-old may both have aggressive risk tolerances, but the 51-year-old has annual college tuition payments for two children and very little saved for retirement. In that example, the 51-year-old may be an aggressive investor, but their ability to financially weather a major market pullback on retirement savings is significantly less than the 21-year-old counterpart without tuition payments. Simplistic or not, the concept sheds light on the impact of time on success in saving for retirement

The market can be unforgiving during certain periods, but the long-term trend is positive. Creating a savings plan early and sticking to it when it is tempting to bust the budget goes a long way to avoiding the shoulda, coulda, woulda’s. Reach out to your advisor for assistance creating a plan or reviewing your existing plan!

 

Nothing contained in this publication is intended to constitute legal, tax, securities or investment advice, nor an opinion concerning the appropriateness of any investment, nor a solicitation of any type and does not guarantee future results. The information contained in this publication should not be acted upon without specific legal, tax and investment advice from a licensed professional. Past results are not indicative of future performance.