When it comes to saving money, a lot of youngsters think of saving as something for older people who want to retire. They think they have so much time to enjoy themselves before they need to worry about that stuff.
Retirement seems so far away that it almost seems like it’s never going to happen. So why bother putting away 20% of your paycheck for something that’s a distant dream when you can instead take that money right now and get boba, get all you can eat kbbq, upgrade your car, travel to Iceland, or buy tickets to that hipster music festival visiting your area?
These are all things my college friends have done by the way, not that there’s anything wrong with that.
Here’s the short answer: time + compounding interest = $$$. Aside from compounding interest, you’re also going to learn early on how to maximize every dollar by starting to build experience handling money now. It’s also going to greatly improve your quality of life knowing you have a nice safety net prepared in case of an emergency.
The number one reason why it’s important to save early is something called compounding interest. The math behind that is summarized by the equation below for compounding returns with regular ongoing contributions:
Where A = final amount after t years, P = initial amount invested, r = annual rate of return, n = number of times compounded per year (let’s assume 12), and PMT = monthly contributions (short for payment).
If you’re not a math person, all you need to know is that more time, initial investment, and monthly contributions means more money by the time you retire. You get more time by investing earlier rather than later. The other two factors that you have less control over are the rate of return and number of times compounded per year. If those are higher, the final amount will also be higher.
The math here says that the earlier you start, the more time you have to take advantage of compounding growth. This means a small amount invested early often can lead to equal or greater savings than a larger amount invested later on.
By putting money away now while you’re young, you’re going to set yourself up for massive returns later on, even if that amount you’re contributing today is just a small amount.
If you started saving 200 a month starting at age 20, you would have $1.275 million by age 60. However, if you waited until you were 30 to start saving 400 a month, you would only have $912 thousand by age 60. Waiting even later until 40 to start saving 1,000 a month, you would only have $766 thousand saved up by 60.
When you crunch the numbers, you’ll see that if you start later, you will end up with less savings by retirement age compared to someone who started saving early. Even if you contributed more money than them overall.
So really by starting early, you’re saving yourself a bunch of money in the long run. And this is why people in their mid thirties wish they could go back in time and shake their 20 year old selves, telling them to wake up.
The table below summarizes the math behind this:
|Start Saving at 20||Start Saving at 30||Start Saving at 40|
|Annual return on investment compounded monthly||10%||10%||10%|
|Total amount contributed until 60||$96,000||$144,000||$240,000|
|Total interest gained||$1,179,556||$768,130||$526,696|
|Amount saved by 60||$1,275,556||$912,130||$746,697|
|Monthly contribution needed to match final amount saved by starting to save at 20||$200||$560||$1,663|
Lessons Learned about Money
Besides compounding return, there’s also some lessons about money you can learn early on if you can start saving when you’re young. These will be crucial skills to learn now so that you’ll have plenty of experience managing your money by the time you hit your mid thirties.
Develop Financial literacy
There’s a lot of concepts that you will need to have a solid grasp of if you plan on maximizing your finances.
At a high level, this includes things like budgeting, saving, investing, and debt. But if you want to go deeper you’ll also want to look into the stock markets, bank accounts, index funds, portfolio diversification, and more.
Without any plan for saving your money, you may come across these terms, but it’s going to be difficult to develop a practical understanding of how these terms relate to you and your finances without any skin in the game.
You definitely don’t want to be forced to make a long-lasting financial decision without first having the experience and wisdom to make a smart choice.
You could always hire a financial advisor, however like all services, there’s going to be a cost associated with that. Typically for a traditional in-person financial advisor, they’re going to take a 1% cut of your assets under management or will charge a few hundred dollars per hour or a few thousand dollars per plan.
Understand how to start saving and living below your means
While you might not have too much money when you’re young, you still have the chance to develop good saving habits that will last you a lifetime.
Once you’ve been accustomed to living a certain lifestyle, it’s going to be very hard to change that (for the better) later on.
If you’ve been living your 20s spending your money wildly with no limits, you’re going to have to make drastic changes to your lifestyle in your 30s once you “wake up” and realize the importance of saving. That’s going to be super tough to do.
On the other hand, if you’ve been living frugally and saving money your whole life, it’s going to be a breeze to keep that up for many years to come.
Learn the importance of saving
Starting to save young will teach the importance of money before you have a chance to spend it all. When you keep track of every dollar that goes into your bank account, you will quickly pick up on the satisfaction that comes with increasing your net worth.
That’s going to be a strong motivator to manage your money wisely once you start making more money.
It’s also best to start early to avoid procrastinating on getting your finances together. Now is the best time to get started, not when you’re in you’re kicking yourself in your mid 30s for not being smart in your 20s.
Make mistakes with little amount of money now
Everyone makes mistakes. Just try not to make them when the stakes are so big.
As a younger person, you probably don’t have much money to lose to begin with (unless you’re talking about going into debt). So when you make your money mistakes now, you’ll only take a small hit, but learn the same lessons. You’re definitely going to want to get those mistakes out of the way and learn your lessons early before having to deal with the same situations with much more to lose.
Falling for a scam and losing $100 will teach you the exact same lesson as falling for the same scam and losing $10,000.
Build Up a Safety Net Early
Your quality of life will improve
There’s no question about it, money does make you happy. More money means much less stress when dealing with emergencies or unexpected expenses.
When you have a nice safety net in place that you’ve built up over time, you will have much less pressure to make difficult decisions because of money. You will never be “forced” to make massive sacrifices to you or your family’s quality of life just to make ends meet.
That’s going to take a massive load off your back just not having to worry about whether or not you’re going to make it through the month in the back of your mind everyday.
it’s easier to build up a savings with less responsibilities
As a young person (especially as a single young person), you’re probably going to have fewer financial obligations than someone who has a family to take care of and a mortgage to pay off. This means you’re going to have a decent amount of spare cash in your pocket.
A lot of young people just out of college who are experiencing earning a decent salary for the first time look at that as their chance to splurge on all the things they’ve ever wanted, but could never afford. I would suggest that you instead take that as your opportunity to set yourself up for financial success in the future.
If there’s one lesson to take away here it’s this: when you save early, you leverage your time via compounding interest for huge gains later on in life.
Besides that, there’s also the improvements in quality of life by having a decent safety net in place. You’re also going to have a better time managing your finances later on with years of experience behind your belt from handling small amounts of money now.
If you’re interested in learning more about investing in general, check out some of these posts:
- Retirement Investing for Beginners
- Financial Milestones by Age
- How to Build an Investment Portfolio
- Stock Market Investing for Beginners: the Complete Guide
- Where Does The Money Go When You Buy A Stock? - November 22, 2020
- Why Is It Important To Save Money At A Young Age? - November 15, 2020
- What To Do If Someone Is Not Giving Your Money Back - November 8, 2020