Saturday, February 19, 2011

Retire By 40: Investment Fundamental #10 - Start Early

Retire By 40: Investment Fundamental #10 - Start Early

Investment Fundamental #10 – Start Early

Posted on January 28, 2011 by retirebyforty
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start early invest
Baby is T-minus 3 weeks, so I’ll need to wrap up my 10 investment fundamentals and write a big “How I will Retire By 40″ post before things get hectic. My #10 is to start investing as early as you can. This is one of the most important rule of investing. When you start investing early, time is on your side and your investment have more time to grow with compound investing.

Compound Investing

Compound investing is the best thing since chocolate cake because every year your gain from the previous year will become the base line for this year. If you invest $10,000 in 2010 and had 10% gain, then you would make $1,000. So in 2011 you will start with $11,000. If you have the same 10% gain in 2011 then this year’s profit will be $1,100. Every year you will make more and more money. As you all know, our time on Earth is limited so the earlier you start, the more you will have when you stop working.

Let’s look at some hypothetical examples.

Joe starts working at age 20 and invested 10k per year right away. We’ll assume 10% gain to make it simple. In 20 years, he stops investing, but he won’t withdraw the money until he completely retires at 68. He will have $3,351,214 in his investment account when he is 68.
Michelle starts working at age 20 and spends a lot of money on clothes, shoes and purses. She wises up and starts contributing to retirement at age 30 and invests 10k per year for 20 years until she is 50 and then stops. In this case, she will have $1,625,989 when she retires at 68.
start early invest graph
They both invested 200k, but do you see the huge difference in the amount accrued at age 68? Even if Michelle keeps investing 10k/year for another 10 years until she is 60, she will only build up her account to $1,860,696. This is because Joe had a 10-year head start on her at the beginning of the race.
Kevin @thousandaire.com made a great retirement calculator. You can check it out and plug in different numbers to see what your retirement may look like. That’s what I used to calculate the numbers above, so if there is any mistake it’s Kevin’s fault. ;) He also made a video showing how you can have $1M when you retire.
OK, I see this calculator is not quite perfect. Michelle’s 10k investment should be adjusted for inflation somehow, but her account still won’t catch up with Joe’s account even with that. Kevin also shows two columns for tax advantage vs post tax account. It’s startling to see how much difference there are in the two. Another lesson learned – put off paying tax as long as you can.

Start Early

In my case, my dad insisted that I contribute to the 401k when I started working. I wrote a guest post about this and it is up at Budgeting in the Fun Stuff if you haven’t seen it – The Best Financial Advice I Ever Received. Thanks to my dad, my 401k account is in good shape and I may be able to retire early.
Remember – Nobody thinks about quitting when they start a new career so they don’t think about retirement. When we’re young, we just want to spend the money, but think how much you are taking away from your future self. So start saving for retirement as soon as you can and future you will be that much happier.
ps. I will max out 529 for baby while I’m still working these next few years to get him started early. Once I stop working, we probably can’t contribute to 529 as much. BTW, isn’t technology AMAZING? I didn’t even know they can do this. The ultrasound technician pushed a button and we can see him smile and frown, so awesome!
  1. LifeAndMyFinances says:
    January 28, 2011 at 4:09 am
    Starting early is key to getting that compound interest rolling! My wife and I have started our retirement funds. While we didn’t start super early, she was only 22, and I was 25, so we’re doing better than most I would assume!
    LifeAndMyFinances recently posted..Will the Nissan Leaf Save Me MoneyMy ComLuv Profile
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  2. Everyday Tips says:
    January 28, 2011 at 6:34 am
    We started our retirement funds when we got our first paycheck at the age of 23. (We got married a week after graduation.) I wish the market had performed better over those 20 years, but I am so glad we invested back then.
    Have you decided which state you will use for your 529?
    I can’t believe how much better ultrasound pictures are now than when I had my last one 13 years ago. The 3D imagery in phenomenal.
    Be ready, that baby might decide to come out any minute!!
    Everyday Tips recently posted..Can A Health Journal Help Me Can A Health Journal Help YouMy ComLuv Profile
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    • retirebyforty says:
      January 28, 2011 at 8:42 am
      I did the same! The Mrs. got started a few years later and had a couple of non contributing years, but her account is catching up to mine.
      I also wish the market had performed better, but I think we are still better off than many more people.
      I heard baby might come any minute, I’m ready! Well, not really I still have to pack a bag, but the Mrs. is ready.
      We probably will use Oregon’s 529, but I heard good things about Utah. I will need to do more research.
      Reply
  3. Jessica07 says:
    January 28, 2011 at 6:49 am
    Great post. Great, great, great post. *applauding wildly* I think you should make this fundamental #1. :)
    Reply
  4. Jessica07 says:
    January 28, 2011 at 6:51 am
    By the way, thanks for posting the picture. I want one. :(
    Jessica07 recently posted..5 Steps to Reclaiming Your EveningMy ComLuv Profile
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  5. Kevin @ Thousandaire.com says:
    January 28, 2011 at 6:58 am
    Congratulations on the baby!
    And you hit the nail on the head with saving early. Compound interest is the best thing in the world when you have enough time to let it grow. (unless we’re talking about inflation)
    Kevin @ Thousandaire.com recently posted..Giveaways Galore!My ComLuv Profile
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    • retirebyforty says:
      January 28, 2011 at 8:46 am
      Thanks for making the spreadsheet. It’s really helpful see my plan. All the retirement calculator I’ve seen does not support stopping contribution at 40. :)
      I also realized why compound interest is the best. It’s because we have a limited time to live. If we live forever, we can always compound later. However, we only live for a limited time so it is essential to start as early as possible.
      Reply
  6. lovely leverage says:
    January 28, 2011 at 8:35 am
    OMG a baby! Congratulations, I am so happy for you! :)
    I totally agree with you “put off paying tax as long as you can”. Taxes is one of things that keeps the poor from the rich.
    lovely leverage recently posted..Leverage and Cash CowMy ComLuv Profile
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  7. Marc says:
    January 28, 2011 at 9:07 am
    Great picture! We didn’t get a 3-D ultrasound with either of our kids as my wife feels they are a bit creepy. I had a 401K that I started while working for a tech company in the .com era but I have had to cash it in (I know bad move) due to circumstances that came our way.
    Reply
    • retirebyforty says:
      January 28, 2011 at 2:07 pm
      Thanks! I need to read up on how this work. I guess it’s just surface mapping, but it is so cool.
      It’s incredible that we can see him moving around and he got all cranky after being poked with the ultrasound device.
      Yeah, life gets in the way of saving sometime.
      Reply
  8. Buck Inspire says:
    January 28, 2011 at 9:41 am
    I think all schools should stress this fundamental rule of start saving for retirement early. Compounding interest sounded Greek to me, but looking back, really should have taken more advantage of time. Congrats on the baby on the way. Exciting! :)
    Buck Inspire recently posted..Entrepreneur AnalysisMy ComLuv Profile
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  9. Aloysa says:
    January 28, 2011 at 10:20 am
    I started contributing when I got my first real job in the US. I think I was 27-28. And I could contribute a lot because my salary was miserable. :-) But as soon as I got a decent job, my contributions increased. I love to see it grow (when it actually grows). I do have a friend who is in this country longer than me and STILL doesn’t have a retirement account.
    Aloysa recently posted..Lesson From Bungy JumpingMy ComLuv Profile
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    • retirebyforty says:
      January 28, 2011 at 2:09 pm
      This last 10 years had been really tough for stock investors. Hopefully the next 10 years will be better!
      I think you’re still better off than a lot of people because you already started. I would guess most people only start investing in their 30s.
      Reply
  10. BeatingTheIndex says:
    January 28, 2011 at 1:25 pm
    Not everyone is able to start contributing early because many people in their 20s are riddled with student loans. Even without any loans, salaries are meager when one first starts a career which makes it very hard to save substantial amounts!
    Unfortunately, I only started in my early 30s, but better late then never!
    BeatingTheIndex recently posted..2010 Canadian Oil &amp Gas Top PerformersMy ComLuv Profile
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    • retirebyforty says:
      January 28, 2011 at 2:10 pm
      That’s my brother. He is already early 30s, just finished school and has student loans. I think as long as you are saving something, it’s still a lot better than most people.
      Reply
  11. The Passive Income Earner says:
    January 28, 2011 at 2:54 pm
    I agree that starting early is key as it builds the proper saving behavior and you have it for the rest of your life. As soon as I started working I started saving. The key is to not get caught up in life style inflation :)
    I believe it’s a 2 step approach though, the compound growth is not that easy and 10% is an insanely large number to achieve. 3 years ago I readjusted my investing philosophy because I wasn’t getting the compound growth I wanted even though I was saving and investing.
    The compound growth isn’t as easy and to beat inflation (or at least keep up with it) you need at least 3%.
    The Passive Income Earner recently posted..Dividend Yield- Scotia Bank TSE-BNSMy ComLuv Profile
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    • retirebyforty says:
      January 28, 2011 at 3:36 pm
      10% is Kevin’s number. :)
      I would be happy with consistent 8%.
      What is your 2 steps approach? Can you share? I know you like dividend stocks. My approach will be about 50/50 rental/stock market.
      I agree compound growth is not that easy especially over these past 10 years. The dot com bubble and the great recession did a number on everybody’s accounts.
      Reply
      • The Passive Income Earner says:
        January 28, 2011 at 6:02 pm
        I meant that first you need to save and start early. Then you work on making your money work.
        The theory of compound growth is awesome, but it’s hard to execute in practice. Back in the 80′s, my parents had interest in the 10%-15% so it was easy but these days you have to work hard to execute compound growth.
        I am like you, I want to do rental and dividend stocks. Rental is hard in Vancouver though, I’ll need to go out of town.
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  12. Deidre @ TransFormX says:
    January 28, 2011 at 3:05 pm
    What a great picture & post :)
    I saved my son’s ultrasound and its in the front of his 1st year baby book. Very cool to look back on it all….he’s 21 this year.
    I save very well but should look into some options for 401K which will help. Since I am self employed that may impact things dramatically.
    Deidre @ TransFormX recently posted..Diabetes And The HCG Diet – What You Need To Know Before You DecideMy ComLuv Profile
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  13. krantcents says:
    January 28, 2011 at 8:28 pm
    This is one of those situations where youth is wasted on the young. Most young people do not want think about retirement in their twenties, maybe the best compromise is investing in a Roth IRA. It has less restrictions and can be used to buy your first home. Maybe another compromise is to think of investing in a 401K as a tax subsidized investment. For the price of a lunch, you can have millions in 35 years!
    krantcents recently posted..Budgeting Is a Waste of TimeMy ComLuv Profile
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  14. Suba says:
    January 28, 2011 at 10:31 pm
    We didn’t start saving for retirement until a couple of yrs ago (we are almost 30 now), but in our defense we didn’t start earning until we were 25. So luckily we wasted only 2 earning years before we wised up. For us the market has been phenomenal. We started putting money away in 2007, market crashed in 2008, which is when we upped the contribution like crazy (not timing the market, just decided to take the plunge and do it). So essentially we bought a lot on “sale”. We are not counting on those, how many more market swings we will have to see before we retire, but it is nice to see the balance. Hopefully we can catch up inspite of starting a little late.
    Suba recently posted..Vanguard vs Fidelity – Which is betterMy ComLuv Profile
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    • retirebyforty says:
      January 29, 2011 at 11:49 am
      You guys still started in your 20s right? That’s a lot better than most people and you still have many years left to invest. We kept contributing through the dip as well and it worked out OK. Our portfolio has mostly recovered. It could have been a lot worse if we stop investing and pulled out the last few years.
      Reply
  15. 101 Centavos says:
    January 29, 2011 at 6:49 am
    I’d say that most readers and commenters are veteran or newly-converted savers. The majority of North Americans are not — hence the abysmally low national savings rate.
    No doubt that starting early yields higher returns through compounding. But for many who financially illiterate or in dire, paycheck-to-paycheck situations, contributing to a 401K or TFSA is often a “next month” resolution.
    Reply
  16. Clay Ivy Finance says:
    January 29, 2011 at 10:23 am
    Warren Buffett said one of the greatest factors to his success was that he started early. Buffett filed his first tax return at the age of 13 taking as $35 deduction for the bike he used to deliver papers. For those of you who are young, start now. For those of you who are older, it is never to late to start.
    Clay Ivy Finance recently posted..3 Choices For SavingMy ComLuv Profile
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  17. Evan says:
    January 29, 2011 at 1:21 pm
    Congrats on the new one coming! Ummm did you sign up for a Pregnancy Pool yet (cough cough lol). When you say max out your 529 do you mean up to gifting limits or do you mean up to your state’s deduction limits?
    Evan recently posted..Cable and Satellite Companies You Can Do BetterMy ComLuv Profile
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    • retirebyforty says:
      January 29, 2011 at 8:35 pm
      Thanks! I didn’t even think about the Pregnancy Pool. I’ll let the Mrs. know.
      I meant up to the deduction limit on the 529. That’s $4,000 in Oregon so we’ll have to set it up after he gets his id.
      Reply
  19. Cowtown Realist says:
    January 29, 2011 at 10:42 pm
    Your Dad is a smart man. I wish I would have listened to my Dad when he told me to contribute to my RRSP when I was a teenager…
    Reply
  21. Yakezie says:
    January 29, 2011 at 11:26 pm
    I wonder if many people do in fact start early and ever reach those lofty numbers though? Or, do they just get shallacked after a downturn, panic, sell, and never get there?
    Yakezie recently posted..Are You Stuck In A RutMy ComLuv Profile
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    • retirebyforty says:
      January 30, 2011 at 7:26 am
      I will ask my friends and see what they do. One guy pretty much quit the stock market and is investing in real estate. Another gal also complain that the market never did her any good so she probably doesn’t have much in the market either.
      The problem with starting early is you don’t know what you’re doing early. Unless you’re in finance or have a good adviser.
      Reply
      • Clay Ivy Finance says:
        January 31, 2011 at 4:44 pm
        People in this situation may be best advised to contribute to a market index fund. If you don’t know what you are doing, take market returns rather than trying to pick indivdual winners. Over long periods of time the overall market return will serve you well. I would suggest this before ever considering owning real estate. If you don’t know what you are doing real estate is tougher. Liability, repairs, and dealing with people come into play much more with property than with stocks.
        Clay Ivy Finance recently posted..3 Choices For SavingMy ComLuv Profile
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  24. Lisa @ Cents To Save says:
    January 30, 2011 at 7:05 am
    Congratulations on the new arrival! I wish I listened to my dad when he said don’t use your credit cards and only pay the minimum. Live and learn… live and learn :)
    Lisa @ Cents To Save recently posted..I Believe in PinkMy ComLuv Profile
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  25. Moneycone says:
    January 30, 2011 at 10:10 am
    When Google went public, the first thing Google did was hire the best brains from the financial industry to educate Google employees about what they are about to receive and how best to manage the new found wealth.
    I wish more companies did that. Atleast for fresh graduates on their first job.
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    • retirebyforty says:
      January 31, 2011 at 9:14 am
      It would have been great if I had more finance education when I first started investing. We would be in much better shape if I had good advisers. Oh well, experience is the best teacher.
      Reply
  27. Roshawn @ Watson Inc says:
    January 31, 2011 at 3:23 am
    First, let me say congratulations!!!!
    I do agree that the magic of compounding interest is still mind-boggling yet so very simple. I do agree that people certainly need to put themselves in a position so that retirement is not a struggle, and the earlier one starts, the less work they have to do. Investing in tax-advantaged accounts dramatically increases the odds of retiring comfortably.
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  28. Squirrelers says:
    February 1, 2011 at 11:52 am
    Big Congrats on baby!
    Also, I agree that compounding and starting early make a great tandem. Let math work in your favor, and don’t procrastinate. Just get started. It really makes a big difference to be action-oriented in this realm.
    One addition – important to consider present value here, as a dollar today is worth more than a dollar tomorrow (unless deflation kicks in).
    Reply
  29. Sandy @ yesiamcheap says:
    February 1, 2011 at 1:06 pm
    Okay a couple of things here. I get the invest early thing. I started my first 401K at 19! It wasn’t much but it adds up over time. :)
    Second thing is that most 20 year olds don’t have 10K to invest. Sorry, it’s the truth.
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    • retirebyforty says:
      February 1, 2011 at 3:15 pm
      That’s the problem with starting early. You don’t have any money and you don’t have enough investment experience. I wish I had a great finance adviser, but I guess we are doing ok.
      Reply
  30. Finanzas Personales says:
    February 2, 2011 at 5:05 pm
    This should be # 1. Not only because it’s an important one, but because it’s so easy to apply!!! However, young people are usually driven to spending much more than they can afford and, by the time they realize the power of compound interest, they first have to pay the debts they took and then start. Lots of time wasted!!!
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