Two weeks ago, I wrote an article in the News encouraging students to over borrow for their education while simultaneously investing money for the future. This week, I want to backtrack and answer the question: “Why on earth would I save for retirement during my bright college years?”
As is so often true, the limitations of our brains force us to ask questions with shockingly simple answers. In this case, we are all limited in our ability to imagine the effects of compound interest. I grew up with a children’s story about a young girl who convinces the Raja to double her rice every day for a month. Beginning with just one grain, she ends up with more than a billion.
If one could fold a sheet of paper in half just 42 times, it would grow thick (or tall) enough to reach the moon. Without reading further than this sentence, how quickly can you figure out how many folds it would take to reach halfway to the moon? Many people struggle with the answer, but it’s quite logical: 41. The final, 42nd fold doubles that.
Understanding the power of investing early is no different: hard to imagine, but easy to calculate. Here are some motivating numbers: Saving $100 a month in a bank for 40 years would leave you with about $48,000. You’d earn just $580 on top of that, if you received our nation’s average 0.06 percent per year in interest.
But investing that $100 a month and earning an average of 8 percent a year in interest would leave you with $350,000. That’s a difference of more than $300,000.
So why invest for retirement now? You are likely thinking that you should wait until you get out of school, or until you’re financially secure (whatever that means) or until you make a high salary. Spending is like smoking cigarettes: The longer you wait to quit, the harder it will be to succeed. And waiting is a dangerous choice when it comes to optimizing your future.
The investor above ends up with $350,000. She started at age 20 and quit at age 60. If she had waited until age 30, though, and invested twice as much ($200/month), she’d only end up with $300,000. She put away twice as much each month and ended up $50,000 poorer. And for the record, if our investor begins at age 20 and stops at age 70, she’d go from $350,000 to $800,000. Ten extra years more than doubles her money.
Here’s one final hypothetical. You take my advice from the previous article, and invest $22,000 during your time at Yale (less than four years’ Student Effort). You never invest a dime after that. Growing at 8 percent a year, your account would be worth $540,000 at age 62. Now imagine you put off investing for ten years. You’d need to invest $4,300 a year for 30 years to do as well as you did in the previous scenario. In the first case, you only invested $22,000 of your money. In the second, you had to invest $130,000 of your money — almost six times as much for the same result.
If all these numbers are beginning to bleed together, don’t worry. It’s normal. Here’s the takeaway: Investing a little in your future today is far more valuable than investing far more several years down the road. And while this all may seem complicated and daunting in the abstract, it’s absolutely learnable.
The implications of these small building blocks of financial literacy cannot be overestimated. I firmly believe that taking steps for your personal financial security is vastly more effective than working to change macro-level flaws that bolster the unacceptable inequality of wealth in the U.S. I don’t claim that we shouldn’t fight to change the system. But while we’re in the system, we should learn to extract from it every possible advantage.
Beginning with a $100 per month investment is a start, and one that will provoke vocal envy in many a middle-aged adult. Remember that saving money each month is nothing like a bill: You aren’t losing anything. You’re simply moving money from your front pocket to your back pocket.