The earlier the better
Committing to a savings plan early in life is one of the key components to building wealth and reaching your financial goals. It’s also a lot easier to achieve than you might think.
Right now, finding extra cash to save each month might seem difficult or perhaps even totally undoable. Maybe you feel the amount you can save regularly now is so small it won’t make any impact on your finances in the long-term. It’s time to challenge that mindset. Starting to save now – even with a small amount – can make a big difference down the track.
Stick with us – we’re going to show you how committing to a regular savings plan has the potential to safeguard your financial future.
The power of compounding
Compounding is a powerful investment tool, especially for young investors. It’s a force to be reckoned with when it comes to wealth building as it helps your initial investment grow over time.
Compounding is generating more returns by reinvesting the return on your asset. Compound returns are exponential so your return increases incrementally over time.
You could think of compounding as your reward for saving consistently – it’s essentially interest on your interest. When you start saving early you create the potential for increased returns simply by holding your investment longer.
Here’s an example
You decide to put $10,000 into a diversified long-term investment. Let’s assume that the return over the period averages out to 6% per annum.
As you can see, just by letting your investment roll over each year the incremental increase on your return becomes more significant over time.
|2019||$10,000 x 6%||$10,600|
|2020||$10,600 x 6%||$11,236|
|2021||$11,236 x 6%||$11,910|
|2022||$11,910 x 6%||$12,625|
|2023||$12,625 x 6%||$13,382|
|2024||$13,382 x 6%||$14,185|
|2025||$14,185 x 6%||$15,036|
|2026||$15,036 x 6%||$15,938|
|2027||$15,938 x 6%||$16,895|
|2028||$16,895 x 6%||$17,908|
|2029||$17,908 x 6%||$18,983|
Here’s what that investment would look like if you added $100 in savings every month.
In this example, you can see that after 10 years the total interest earned is actually greater than the regular amount that has been put in. Starting your savings plan early allows you to harness the long-term benefits of compound returns.
Time is money
Time is a key factor in wealth building. Given the time value of money, we know that one dollar today is worth more than one dollar in the future.
The numbers below tell the story of why it’s so important to start saving early in life.
Let’s set a goal of accumulating $500,000 by age 60, assuming an annual return of 6%.
To achieve this goal a 25-year-old would need to invest $351 a month.
A 35-year-old would need to invest $722 a month. And a 45-year-old would need to invest $1,720 a month.
As you can see, the 45-year-old must invest more than four times the monthly amount to reach the same goal as the 25-year-old.
Starting to save when you’re younger allows you to take advantage of compound returns. While you’re working hard so is your money and this can be especially helpful when you’re planning for retirement.
How to save
If you find it difficult to save, start by setting a realistic, achievable, short-term savings goal. This can motivate you to form a long-term savings habit.
Commit to saving for something that will deliver a tangible result. Maybe it’s your next holiday or a little luxury that you wouldn’t usually splurge on. Setting up a direct deposit can be very effective as once it’s operating the withdrawals and deposits happen automatically – you don’t miss what you don’t see.
Once you’re in the regular habit of putting money aside, saving for the long-term becomes part of your financial life.
Where to save
Savings accounts are an obvious choice, but there are other options that may deliver better returns and be more suited to your individual circumstances.
Topping up your super with regular contributions can be an excellent option as it offers the benefits of long-term compounding growth in a low tax environment. The little extra you put in now can help pay for those big-ticket items in retirement.
You could also consider growing a nest egg outside of super by establishing a personally held, diversified investment portfolio.
This allows you to benefit from compounding even further by reinvesting your dividends or distributions back into the share market. This incremental increase in your investment can have advantages as part of a long-term strategy.
Good cash flow
Cash flow is another benefit of committing to a long-term savings plan.
It might sound a little counter-intuitive at first, but as we saw in the examples above if you start saving early your regular commitment is less.
Compounding helps your money work harder so you can enjoy life now and in the future.
If you plan correctly, you can have more in your pocket today and be in a stronger financial position in the future.
Don’t sacrifice savings
When cash flow is tight it can be tempting to dip into your savings account or pop that extra expense on your credit card.
But the long-term effects of sacrificing your savings can be significant.
Regular long-term saving is the key safeguarding your financial future.
Don’t be fooled into thinking you’ll be able to make up today’s saving by contributing more later on.
Retirement might seem a long way off right now, but life moves at a frantic pace.
The earlier you start planning, the more opportunities you’ll have to build wealth along the way.
A trusted financial adviser can provide industry expertise and market intelligence so you can make decisions that match your investment goals.
Committing to a regular savings plan that unleashes the benefits of compounding is another example of the many advantages of long-term planning.