How the power of time can help savvy young investors grow an impressive portfolio.
If you tell the average 22-year-old that the best time to start saving for retirement is yesterday, they may throw you an incredulous glance. “Are you kidding?” they may say, “I’m not due to retire for another forty years!”
The argument you may hear from Millennials and even some older members of Generation Z—those born between 1997 and 2012—is that they’re busy starting a family or paying down student loans and they simply don’t have the money to worry about retirement.
Our polling1 shows that many young adults are, in fact, worried about having enough savings for their future. For example, nearly one in four Millennials, born between 1981 and 1996, are concerned about having adequate savings to meet their financial needs, while 67% are uneasy about making that money last a lifetime.1
However, having time on your side is a tremendous advantage. Participating in a retirement plan early in your career may be the single easiest way to retire with an impressive nest egg.
The magic of time
Here’s a hypothetical scenario that puts things into perspective:
Say 22-year-old Bob makes $60,000 a year and plans to retire at 65. He contributes 10% of his pre-tax salary into his 401(k) plan retirement account while his employer chips in 2% in matching contributions. Assuming he consistently makes that 12% monthly contribution of $600 to Bob’s 401(k) plan account and earns a hypothetical 5% rate of return on such plan investments, he’ll end up with $1,057,228 at retirement.
Sally, however, contributes $1,000 a month to her 401(k) plan account at the same hypothetical rate of return at Bob, but she doesn’t start contributing to her retirement account until age 45. By the age of 65 she will have $407,458 in her 401(k) plan retirement account—just 39% of what Bob has saved.
While many investors go in search of the magic double-digit stock gain, young investors shouldn’t overlook the power of consistent contributions to their retirement accounts—even if the contributions begin very small.
Hypothetical results for illustrative purposes only and are not representative of any particular investment.
Even small amounts make a big difference
A frequent complaint from young investors is that they simply don’t have the excess cash to contribute to their 401(k) plan account or other retirement savings vehicles. Using the example of Bob and Sally, let’s take a look at this misconception.
Say Bob complains that he can only afford to put away 4% of his paycheck each month due to his student loan payments and tight budget. Assuming the same rate of return for 401(k) plan investment over 43 years and a 2% employer matching contribution to Bob’s 401(k) plan account, he will have $528,614 at retirement—still significantly more than Sally even though his monthly and overall contributions were considerably less than hers.
Hypothetical results for illustrative purposes only and are not representative of any particular investment.
While that may not be enough for Bob to retire on, a study by the U.S. Census Bureau showed that 49% of adults ages 55 to 66 in 2017 had no personal retirement savings.2
Now, of course, investment returns on 401(k) plan investments aren’t usually as steady as our hypothetical example and rates of return typically will fluctuate over time. But with enough time on one’s side, even small contributions to a 401(k) plan or other qualified retirement account can make a big difference to an overall retirement portfolio.
Financial education that pays in the long run
Many young investors are also unaware about Modern Portfolio Theory, which looks at how an investor can build a portfolio to optimize expected returns for a given level of risk, or the importance of making consistent contributions to a 401(k) plan on a pre-tax basis. A Financial Advisor can also help explain asset allocation and investment diversification to help smooth long-term returns through bear and bull markets.
But first and foremost, young investors should consider the pre-tax nature of contributions made to a 401(k) plan and how to put the power of time to work for their retirement savings. Often, these contributions may be the most important investment they’ll make for their retirement.
