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| How To Get Young People To Save By William Hammer, Jr., CFP® November 30, 2011 |
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"Give me a lever long enough and a fulcrum on which to place it, and I shall move the world." A few weeks ago, my 24 year-old, soon-to-be-married cousin emailed me a few financial questions. His email immediately brought me back to that frightening moment (shortly after I had proposed to my wife) when I started worrying about my financial future. So I invited him over for an early Saturday morning breakfast. Six cups of coffee and a dozen eggs later, we had worked through most of his questions about mortgages, renting vs. owning, credit cards, insurance, and a host of other things. Although he admitted that all of these topics were relevant and important, they were not necessarily as interesting to him as investments. Sensing that I might have given him a stronger dose of reality than he had expected, I wanted to leave him with something inspiring. So I pulled up a compound interest calculator on my laptop. The calculator had five variables that you could manipulate - initial investment, annual savings, annual percentage increase in contributions, years, and interest percentage. After spending about ten minutes playing with different scenarios, he and I were knocked over by two things: (1) Being an early and consistent saver beats being a superstar investor. Changes in investment returns don't change your future portfolio value as much as changes in annual savings or time period, especially if your contributions increase at an above-inflation rate. (2) If you start saving early enough, you don't need to be a huge earner to build significant wealth. A young couple who saves a few hundred dollars a month (even with a modest initial investment) can surely become wealthy over time even with reasonable returns. The compound interest calculator also clearly showed my cousin that investment returns are driven by three levers - capital contributions, time, and the growth rate you earn on those investments. Unfortunately, the growth rate is the factor that virtually everybody, advisors and clients alike, spends their time worrying about. If we know that every piece of research confirms that it is highly unlikely to beat an index fund portfolio over an investment lifetime, then why do we fret over market movements? The time we provide for our investment growth is also hugely important, but we have control only over the time we give investments in the future. We cannot go back in time and start investing earlier than today. We might be able to delay retirement by two or three years, which may help things, but it's unlikely that we would delay retirement by five or ten years. However, it is the initial capital contributions and, more importantly, subsequent capital contributions that really move the numbers. If a couple invests $1000 at an 8% interest rate, they will end up with just about $22,000 in 40 years. If they increase the growth rate to 9%, they will have a little over $31,000. But if that same couple can add $50 a week to the original investment, they will have almost $750,000 in 40 years. That probably won't be enough to retire on if we account for inflation, but it's not exactly chopped liver either.
This chart is pretty elementary, but it tells a powerful story about what truly matters in investing. Yes, returns matter, but not nearly as much as savings rates. Which is easier for the couple to do, find $50 a week or find an extra 1% a year over 40 years? If the answer is so obvious, then why do we all spend so much time worrying about the one lever (growth rate) over which we have so little control? Why not work on the two levers (time and capital contributions) where we can make a huge difference and are within our control? If the numbers in the chart above make you wish that you had started to save earlier, then pass this article along to one of your young family members, friends, or co-workers who might not be as focused on saving as they should be! It feels great to help a young investor get off to a good start. I highly recommend it. FA
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