I believe many people invest with the mistaken assumption that what you invest in is what matters most as opposed to how much and how often you invest. Now, I certainly would agree that what you invest in matters quite a bit. However, when you analyze the investing process you will find that the amount you can afford to regularly add to your investments and the length of time you have to invest and allow your investments to compound can matter more.
If someone asked me what advice I would give to a younger investor if I could only give them one bit of advice, I would tell them to start investing early. That way, compounding is on their side. Of course, better investments will compound more, while lesser investments will compound at a slower rate. The more time you give your investments to compound, the more money you will have when you retire.
If I could give young people a few more bits of advice, I would suggest they save at least 10% of their annual income, but 15% is even better if they want to accumulate a reasonable nest-egg for retirement. I would also recommend they look at the Roth IRA and 401(k) as some of the best savings and investing options in the early years. Letting money compound on a tax-deferred basis (using a 401(k) for instance and taking advantage of an employer match) is great, but investing on a tax-free basis (with a Roth IRA) can be even more powerful over the long-term.
Let me explain why investing early is so important using a quick example of two hypothetical investors.
Suppose Jennifer opened a Roth IRA at age 18 and for ten years she contributed the maximum contribution amount of $5,500 per year. After those first 10 years, she never invested another penny into her portfolio, so her total investment amount was $55,000. Let’s also assume that Jennifer was aggressive, invested 100% in stocks and earned an average 9% return, which is slightly less than the average return of stocks between 1928 and 2013.
Our second investor, Jeff, is a bit of a procrastinator, and waited until age 28 to start investing. However, once he started investing he did so every year without fail until age 65. Jeff is also aggressive and earned 9% throughout his retirement accumulation years. He invested the same $5,500 per year as Jennifer, but his total investment was $209,000 since he started later and vowed to save longer to make up for it.
At age 65, Jennifer’s investment of $55,000, started early, had grown to $2,209,000! Jeff’s portfolio had grown as well, but surprisingly, or maybe not so surprisingly, his portfolio is worth quite a bit less. Even though he set aside money for 38 years instead of only 10 like Jennifer, and even though he had saved almost four times as much as Jennifer ($209,000), by starting later, his portfolio had 10 less years to compound and only grew to $1,554,000.
As you can see, compounding makes a dramatic difference and in this particular example almost quadrupling the investment still couldn’t make up for 10 year delay. That is why the most important advice I can give young investors is to save often but, more importantly, start saving early!
