You may be thinking, “I just started my career, why should I start a retirement fund now?”
The answer is simple. Even though retirement is still 50 years away, it's important to start planning for it now. It can be easy to feel like we don’t need to save much when we’re young, because we have plenty of time to do it.
However, starting to save at a young age helps you take full advantage of compound interest and save more. Knowing how compound interest works can inspire you to save money early in your career for maximum benefits.
How Compound Interest Works
Let’s say Sally starts an IRA at 25 years old and puts in $6,000 a year ($500 a month) for 10 years. After 10 years, at age 35, Sally stops making contributions to her account and allows interest to take over. She put $60,000 into her retirement account. By the time she turns 65, she will have around $658,000 with a 7% annual interest rate.
Now let’s say Sally has a friend named Rachel, but Rachel doesn’t start investing in an IRA until age 35. Rachel puts the same $6,000 a year into her account until she retires at age 65. Even though Rachel put $120,000 more into her account than Sally – and saved for 20 years longer – she will have just under $610,000 in her IRA at retirement, assuming the same 7 percent annual return.
How is it that Sally saved so much less than Rachel, but ended up with so much more? That, my friend, is the beauty of compound interest.
Compound Interest Benefits You the Most if You Start Young
Some young people think it's okay to wait a year to start saving for retirement because the returns are small in the first year. However, you actually lose your last year of returns when you wait, not your first. This may end up costing you thousands of dollars, depending on the balance of your account when you retire.