You must be thinking to yourself, is this guy crazy? Why on earth should you save for retirement when you haven’t even started a career yet? The answer to that question is the miracle of compound interest. Compound interest is where you not only earn interest on your original investment, but you also earn interest on your interest. For example, if you put $1,000 into an account earning 5%, at the end of year one you will have $1,050. As long as you let the $1,050 in the account, at the end of year two you will have $1,102.25. In year two, you earned $50 on your original investment plus an additional $2.25 on the interest you received from year one. You may be thinking that this seems very minor, and for the first few years it is. However, as time goes on, interest keeps adding up and compounding. Let’s look at a more complex example to see more drastic numbers. If you start saving just $100 a month at the age of 18 and continue doing that until you are 65, you will have $621,238 assuming a modest 8% return. Over those 47 years, you would have invested only $56,400 of your own money and the rest was the result of compounding interest. However, the longer you wait to start investing, the less effective compound interest will be.
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Make sure you invest your money in a tax-sheltered retirement account. You don’t want to pay taxes every year on all your earnings.
Morp, you are absolutely right! I originally submitted this article to a newspaper and it included more about using tax-sheltered accounts. For most younger individuals I would recommend a Roth IRA.
Yowza, I am 22 years old and I would L-O-V-E to start up a Roth IRA! I even looked into ones where all I need to do is deposit 50 bucks a month. It’s just that I would be using student loan money to do that because I’m paying for school myself, and it’s EXPENSIVE! I can’t convince myself to invest money that I’m already paying interest on! And any side money I earn from babysitting or summer jobs, I feel like it should go to school expenses. I’m graduating from dental school in 2 years with over 150k in debt. I will be making decent money out of school…because I’ll be a dentist. But I still feel sad about losing these early years of compouond interest. Any suggestions Adam?
@Marilyn – The sooner you can start saving the better. Many people will tell you that if you can get a better interest rate by investing borrowed money you should do it. In other words, if you can borrow money at 4% (your student loans) and can get something higher like 8% in your retirement account, you should invest it. I’m not sure how I feel about that because you are still taking on debt and no matter what the rate is, it still feels like a burden over your head. If it was me, I would wait until I was able to invest my earnings from a job. At that point I would sock as much money away as humanly possibly while still making payments on your student loans. At this point, I am not a professional so if you want real advice, seek the assistance of a professional financial planner. Sorry, I had to put that! Good luck in school!