Individuals in the Gen Z generation -- those born in the late 1990s and early 2000s -- have one huge advantage over the rest of us when it comes to saving and investing for retirement: time.
There may be no bigger advantage that an investor can have than time -- not advanced degrees or years of stock market experience. That may sound like a hot take, but it's true. The reason that time is so critical boils down to one thing: compound earnings, or compounding. Here's why.
Time is on your side
The oldest Gen Zers among us right now are around 25 years old, presumably either a few years out of college or several years into their adult working life. Whether you are working a full-time job on your career path, freelancing, pulling part-time hours, or still in school, it behooves you to start investing for retirement as early as possible.
Money may be tight for people in this age group, but even if you're saving just a little, it is more than worth it -- a little will go a long way, due in large part to compounding.
In very simple terms, compounding happens when money you've earned on an investment starts generating its own returns. For example, let's say you invest $500 in an exchange-traded fund (ETF). In your first year, you earn a 10% return on that investment, adding $50 to your balance so you're left with $550.
Then, in year two, your ETF climbs another 10%. But instead of gaining just $50, the 10% gain on your $550 position adds $55 to your holdings. That $50 you made in the first year earned you an additional $5 the second year.
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It may seem small and insignificant, but when you pile up those earnings on top of earnings for 20, 30, or even 40 years, the growth is astonishing. Just how much are we talking about? Let's run through another example.
If you're currently 25 and plan to retire at 65, you have 40 years to watch that $500 initial investment grow. Assuming you take the simple route of investing it in an S&P 500 ETF and average 10% annual returns (the long-term average for that index with dividends reinvested), you would have about $22,630 after 40 years. That's without adding a single dime to your initial investment.
To see the crucial part time plays in this scenario, the same investment held for just 20 years would leave you with only $3,364. As you can see, doubling your holding period doesn't just double your return but push it nearly eight times higher -- that's the power of compounding.
To make $22,630 on an initial $500 investment in just 20 years, you would have to average a 21% return over that period. Not even Warren Buffett has that kind of long-term track record: An analyst last year showed Buffett has averaged a 20.1% return for Berkshire Hathaway shareholders since he took over as CEO. Time is indeed the great equalizer.
Keep it simple
The scenarios above don't account for any ongoing contributions you're likely to make to your retirement accounts. If you're setting aside an extra $500 every year, your savings would grow to nearly $244,000 after 40 years.
If time in the market and the power of compounding are the most important things that Gen Zers should know, the second thing to know as a young investor is to keep it simple, at least initially.
You don't need to build a diversified portfolio of individual stocks -- just start with a broad ETF like one that tracks the S&P 500, the Nasdaq-100, or another index, and go from there. These types of ETFs will tpyically be concentrated in major large-cap stocks like Apple, Microsoft, Amazon, and Alphabet, among others.
Over time, as you become more knowledgeable and experienced, you can choose to branch out into individual stocks or other assets, but you don't need to be an expert to start -- you just need time.
