Chip and Spence are both 25 year old colleagues with identical professional background. They differ in lifestyle choices and investment outlook.
Between the two of them, Chip believes in investing at an early age and making small sacrifices as early as he can so he could have a decent retirement fund. So, he started investing on his 25th birthday – putting aside $250/month in long term investment funds averaging 10% per year. He continued investing monthly for 10 years until he got married and started a family at age 35. Between providing for his family, a mortgage, family vacations and setting money aside for his children’s college tuition, he barely have enough money to put extra money aside for his retirement. So, he never contributed to his investment after that. However, he kept his total fund invested for 30 years until he retired at age 65.
Spence, on the other hand ‘lived large’ for 10 years – eating out on a regular basis, buying season tickets for his favourite hockey team, enjoyed luxury cars, expensive clothes, and expensive vacations. Never had the idea of setting money aside for investment crossed his mind. That is, not until the recession came and the possibility of massive layoffs crept in. Since then, he decided to remain single and made small sacrifices in lifestyle. He started saving $250 a month – a small percent of his salary at age 35 and continued to do so for 30 years until age 65. In the 30 years, his investment returns averaged 10% per year.
Who among the two will have a larger retirement fund at age 65?
Let us look at the numbers:
Spence obviously invested longer than Chip – a total of 30 years, 20 years longer for the same amount per month and same rate of return at 10% per year. However, he ended up with only $569K at age 65:
- Invested $250 per month for 30 years at 10% per year (monthly compounding) = $569,831.33
Chip only invested only for 10 years (20 years shorter) but compared with Spence, invested 10 years earlier:
- Invested $250 per month for 10 years at 10% per year (monthly compounding) = $51,638.01
- Invested same $51,638.01 for 30 years at 10% per year (monthly compounding) = $1,024,363.83
The result, Chip, despite investing only $30K ended up a millionaire ($1M). Spence invested $90K and ended up with $500K – half that of Chip’s.
The moral of the story. Long term investments need one thing – time. The earlier you invest, the more time you have for your money to grow.