A recent Wells Fargo survey found that just over half of millennials are actively saving for their retirement. The rest think their employer's plan will cover their retirement, simply can't afford to save any money, or believe that retirement is so far in the future that it's not necessary to start saving just yet. In reality, however, nothing could be further from the truth.
Compound returns are the most powerful weapon investors have
When your investments make money, they compound over time exponentially. What this means is that even if your returns stay constant on a percentage basis, the dollar amount your investments earn will rise year after year.
One common misconception, especially among younger investors, is that they need to save enough money to support themselves in retirement. On the contrary, they need to start saving early enough and invest in a manner that will produce enough growth to support their retirement. The vast majority of your retirement savings should come from growth, not from the money you set aside.
Compound interest has been referred to as the "eighth wonder of the world," and for good reason. Harnessing the power of compound gains is one of the most certain paths to long-term wealth creation, as we'll see in a moment.
The most important decade
Because compound gains depend on the amount of time your money is allowed to grow, a dollar saved now is much more valuable to your retirement than a dollar saved five years from now.
As an example, let's say that you want to retire with $1 million in savings. If you wait until you're 35 to start saving and investing, you'll need to set aside about $815 per month in order to retire with a million dollars at age 65, assuming a 7% annual investment return. And, that million dollars will have cost you about $294,000 in contributions over the 30 years you had been saving.
However, if you started 10 years earlier at age 25, you would only need to save less than $390 per month in order to reach a million by 65. And, the vast majority of that million dollars would come from your investment gains. Over the 40 years of saving, you'll only end up setting aside about $186,000. The other $814,000 comes entirely from compounded investment gains. That's why it's so important to start early.
Continuing this example, here is how much you would need to set aside to reach $1 million by age 65 depending on when you get started.
|Age you start Investing||How much you need to save each month||Total Amount you need to save||Total investment gains|
Every little bit helps
Finally, don't let excuses get in your way of taking advantage of the most important time of your life to a secure a happy retirement. There is no better time than now to open a retirement account like a traditional or Roth IRA, which will let you enjoy years of tax-free investment growth.
Even if you can't afford to save much, something is better than nothing, and could make a substantial difference over the long run. If you're 25 years old, every $100 you save could grow into about $1,500 by the time you are ready to retire, and this is assuming an annual return that's actually less than the historical average. So, it's important to save what you can while you're still young enough to take advantage of the vast amount of time you have to invest.
By starting as early as possible, you'll get a head start toward the financial security many people only dream of, and at a fraction of how much it would cost if you decided to wait to start saving.
Matthew Frankel has no position in any stocks mentioned. The Motley Fool recommends Wells Fargo. The Motley Fool owns shares of Wells Fargo and has the following options: short April 2015 $57 calls on Wells Fargo and short April 2015 $52 puts on Wells Fargo. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.