One of the best financial moves new graduates can make is to start investing early. When you start investing in your twenties, you can contribute less each year, yet have more by the time retirement hits than those who wait. This is all thanks to the law of compounding returns.
Why starting early matters
Compound returns occur when interest earned on an investment also earns interest. The longer investments compound, the larger your returns will be.
The table below shows the impact that investing early can have on total returns. These investors made $5,000 annual investments and earned a 7% return each year.
|Investor||Investment Duration||Total Returns|
|Early Ellen||40 years||$1,068,048|
|Procrastinator Paul||30 years||$505,365|
Early Ellen invested ten years earlier than Procrastinator Paul and enjoyed ten extra years of compounding returns. As a result, Early Ellen's total returns are more than double those of Procrastinator Paul. The 10-year delay may not seem like much, but the difference in total returns is significant.
A recent survey by Bankrate indicated that Americans' biggest financial regret is not saving enough for retirement. Thirty-seven percent of baby boomers say they wish they had saved more for retirement. Learn from the mistakes of your elders, and start early.
Reasons you wait and why you shouldn't
You have valid excuses why you're not investing now. Here's why you should invest anyway.
- My paycheck is too small to bother investing. Investing even small amounts will pay off big later. If you invest just $50 a month for 40 years and earned just 5% interest, you would have over $75,000. If you earned 8%, you would have almost $175,000. That won't fund your whole retirement, but it shows that small amounts can add up to something significant. When you earn more, invest more.
- I have student loans to repay. Today, you have student loans to repay. Tomorrow, you may have an auto loan, graduate-school debt, or a 30-year mortgage. If you delay until you're completely debt free, you may be approaching retirement age before you start. Paying off your loans is important, but they likely have low interest rates and you have a long time to pay them back. You can never get back the early benefits of compounding interest.
- I don't know anything about investing... what if I get it wrong and lose all my money? You don't need to have the insight of Warren Buffett to get it right. Remember, you're not trying to make a quick buck by timing the market. You're not touching that money until you retire. Start by investing in a low-cost S&P 500 index fund. Next, educate yourself using resources like The Motley Fool and others, making adjustments to your investing approach as you learn. The biggest mistake you can make is not starting.
You're convinced. How do you start?
Many employers offer retirement plans like 401(k), 403(b), or 457 plans, and some match your contributions up to a certain amount or percentage. If you're not taking advantage of the matching contribution, you're giving up free money. Check your employer's plan through the human resources department.
If your employer doesn't have a match or many investment options, you can open a traditional or Roth IRA. Many discount brokers and banks offer these products. Since you have a long investment horizon, most advisors will recommend a Roth IRA since the interest will grow tax free and you won't have to pay taxes on the gains when you make withdrawals at retirement.
Investing early and regularly are the keys to building wealth. Start today. Your future self will thank you.