Why You Need to Start Saving for Retirement Now: Compound Interest

Why you need to know this: Compound interest on your investments will make you totally rich.

Ugh, I know. Just reading the words “compound interest” makes me want to close this tab too, but do yourself a favor and learn about this now, because compound interest is the reason why I started saving for retirement when I was 25, instead of putting it off until I have a mid-life crisis at 35 and realize I need to start saving money or else I’ll have to work for the rest of my life (you don’t want that). It’s the reason why I’m on my way to having a million dollars saved by the time I’m 65 years old.

“But, retirement is so far away!” you argue to yourself. “And I really want to use this money I saved to take a trip to China this summer to, like, really understand how all the gadgets I own are manufactured.”

Yeah, that’s really conscientious of you, but no. You really need to start saving now, because if you do, you’ll be able to retire at a normal age and do all the traveling you want while flying first class on all the best hovercrafts (this is what I’m guessing the world will look like in the year 2045 and I am a retired person). The earlier you start putting money into a retirement account, the more interest you’ll accumulate over time. This is called compound interest, or earning interest on top of the interest you earned in previous years.

Let’s say you’re 25 years old, and you put away $300 a month into an individual retirement account (IRA), and your account earns you an average of 8 percent each year. If you did this regularly for the next 40 years, you would have contributed a total of $144,000 in your account, but would have a little over $1 million saved by the time you were 65. Congratulations, you’re a millionaire! 

Here’s what I just said in chart form, because we all love charts:

But if you waited until you were 35 to start putting $300 a month into a retirement account, you would have about $440,000 saved by the time you were ready to retire at 65. Waiting 10 years to start saving would cost you $567,000. Math! This is why saving as early as you can is so critical.

Even if you were to put a one-time deposit of $5,000 into a retirement account at 25, forget about it, and never deposit another dime, you’d still end up with about $109,000 when you retired at 65. Seriously, you guys, this is the magic of compound interest.

So for the sake your 65-year-old self, start saving. Do it. It doesn’t even have to be a lot. I wasn’t earning very much when I was 25 and first started putting money into a retirement account, but the point is that I was making myself get into the habit of saving regularly. I started with $100 a month, and now I’m socking away $400 a month. I’ll be seeing you on the hovercraft. Join me in first class, won’t you?

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7 Comments / Post A Comment

Ugh, it’s always so depressing to read this stuff when you’re in your thirties and have no retirement savings. I wish I hadn’t moved out of my parents’ house at such a young age.

Jake (#207)

Except that shit doesn’t grow at 8% any more, and probably won’t for quite a while yet. At the much more realistic 4.5%, 300$/year for 40 years only comes to $395,000. Not only do we need to start saving early, we need to save bigger percentages of our incomes than our parents did.

Mike Dang (#2)

@Jake It’s true that there is no way to project how the market will perform, but here’s some info provided from Standard & Poor’s to consider: From January 1970 to December 2009, the average annual compounded rate of return for the S&P 500, including reinvestment of dividends, was approximately 10.1%.

That includes the recessions of the early ’70s,’80s, and ’90s, the dot-com bubble burst, and the housing crisis and recession of the mid and late aughts. Save early and regularly — even when the market is low (i.e. buying low), because the market will eventually correct itself.

Sure, tell everybody its for your retirement account. Can you have my boss cut two checks. What’s wrong with the car. Those pricks know!

Maybe I just have really good company matching and its requirement to save for retirement at x% but obtaining $1 million by age 65 is a given even at 5% earning. That leads me to another point – $1 million is not enough to retire on. Am I missing something?

ashleyj18 (#3,693)

8%? What recession do you live in? More like .8%.

EA_Mann (#5,000)

The general rule of thumb I’ve heard is to take the amount you’d need to live per year in today’s dollars, put it in an inflation calculator to get future dollars, then divide by .05. Meaning you’d want to take out about 5% a year in retirement and you want it to last about 30 years.

So…back of the envelope, if you needed 60k per year to live (remember your house should be paid off by retirement, kids gone) and you’re retiring in 30 years, that’s about 141k per year in future dollars. Div by .05 – so you’d need $2.8M saved to have this quality of life.

This number can be reduced somewhat if you substract what you’ll get from social security each year (if it exists), if you have a pension (very rare), or if you plan to choose to continue working in some limited capacity.

But yea, Jul is right – in general, 1M is not enough.

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