When it comes to planning for retirement, the concept of deferring consumption and early investing holds significant importance. This blog explores the advantages of beginning retirement savings early and leveraging the power of compounding, highlighting how time plays a crucial role in building wealth for the future.

The Advantage of Time

Time is a valuable asset in the realm of investing. Starting to save for retirement at a young age provides a significant advantage due to the power of compounding. Intuitively, most individuals tend to treat $1 as $1, however, the idea of consumption deferral (rather than immediate consumption, investing and delaying consumption) suggests that the value of $1 depends on how it is allocated. For example, $1 spent on a good or service that one can immediately use or consume has value to an individual, but even with a modest return of 7% per year, investing that $1 at age 20 can yield approximately 18 times the initial investment by the age of 65. In a sense, that $1 gets transformed into having a present-day value of $18.

This exponential growth is attributed to the reinvestment of earnings, where each year's gains generate additional returns in subsequent years. By starting early, individuals harness the full potential of compounding, allowing their money to work harder and grow significantly over time. In the below chart, we have visualized the leverage that is at one’s disposal by beginning their investment journey early. One dollar invested at the age of 20, growing at 7% per year becomes ~$21 by the age 65. As this individual ages, the future return of $1 invested shrinks – ie. at the age of 45 $1 invested for the next 20 years is ~$4. While most individuals’ incomes rise as they progress in age, this chart demonstrates that a lot of the foundation of retirement savings can be built in the early years.

Maximizing Wealth For Retirement

Starting to save early, even with smaller amounts, allows for a longer investment horizon. This extended time frame creates an opportunity to weather market fluctuations, benefit from long-term growth trends, and take advantage of the compounding effect. The growth of wealth over several decades can result in a substantial nest egg for retirement. Moreover, the power of consumption deferral comes into play. By resisting the urge to spend excessively and instead saving and investing a portion of income, individuals can defer immediate consumption in favor of long-term financial security. This practice, combined with early investing, sets the stage for a robust retirement portfolio that can provide a comfortable lifestyle in later years.

Framed another way, we have taken the average present-day value of a $1 invested at each five-year age bracket with a 7% annual return. For example, between the ages of 20-25, $1 invested until the age of 65 represents a roughly 18 times return on investment. Here we can really visualize the importance of building a retirement savings plan in those years between the ages of 20 to 35.

This post is not to deter those that are beyond the age of 20 and looking to invest, but rather a reminder to those that are still in the early years of accumulation that time is on their side. Even though the leverage in the later years is much lower than those at the age of 20, at the age of 55, $1 invested growing at 7% per year still represents a 2X return on that investment, certainly nothing to scoff at. Understanding the power of consumption deferral and early investing is crucial for building a successful retirement plan. By capitalizing on the advantages of time and compounding, individuals can maximize their wealth and ensure a secure financial future. Start early, harness the power of compounding, and set the stage for a prosperous retirement.

Research for Today, Invest for Tomorrow.

Twitter: @5iChris