Tuesday, August 18, 2009
I am in my early 20s, isn't it too early to start saving for retirement?
My niece is in her early twenties and asked me whether or not it is too early to start saving for retirement. To answer her question, I ran some simple calculations.
Let us start with a few assumptions:
Let’s assume that she will not need the money for forty two years (she will be sixty five), that the annual average rate of return on her retirement savings is eight percent, and that the annual rate of inflation is three percent.
Now we can look at two possible scenarios:
She does nothing for the next twelve years, and begins saving at the age of thirty five. She saves $10 thousand per year, and in thirty years she will have saved about $513 thousand. Discounting inflation, that would equal about $150 thousand today.
Or
She saves $2 thousand for the next two years (she will be a starving graduate student and will probably not have more to save); and then $5 thousand per year, increasing for inflation for the next fourty years. In fourty two years, she will have saved about $1,891,000 , worth about $550 thousand today.
In the second scenario, she would accumulate three times more money when compared to the first. It would allow her withdrawing $25-33 thousand a year in retirement relatively safely (in today's dollars). This would be my advice to her for right now.
Is it realistic? I think so. In two years when she finishes her Masters Degree most likely she will find a job that might pay around $50,000. So her retirement contributions would be about 10% from her pay.
Though this may not be enough to allow my niece the lifestyle that she would like to enjoy, it will get her into the habit of saving. It will also give her first hand experience with investing and allow her to see the results. As time goes by, the plan will change. Most likely, her income will grow, her lifestyle will change, her household will multiply, and her assets and liabilities will alter. But overall, she will have a sense of security about her retirement savings and her financial future.
Subscribe to:
Post Comments (Atom)
It is about balancing "living" now with "living" 40 years from now. Retirement planning needs also needs to accommodate the lifecycle of spending: people are net spenders before 35; they reach their top earning potential in their late 30s and early 40s, and it is the 45-55 period in which their income is highest and their expenses lowest (with the greatest potential for saving). There needs to be proper account for major expenses that come in the earlier stages of life, when income tends to be lower, and that can affect the quality of life.
ReplyDeleteThose are valid points.
ReplyDeleteHowever I would argue that you can start saving in your 20s and 30s without sacrificing your lifestyle.
I personally know many people who literally 'live' now by not only spending what they have, but extensively borrowing and not saving at all. And then all of the sudden when they need money they are screwed. They lose places to live, their personal relationships are broken. What is good in this?
By saving earlier and being disciplined in this you can reach and ensure your financial independence much more earlier in life!