RETIREMENT PLANNING: MAXIMIZING THE POWER OF COMPOUNDING
"The early bird catches the worm." – William Camden
Coming up with a retirement egg is not something that can be done overnight. While it is not easy to create one, there are some merits to starting a retirement savings plan early.
How huge your retirement fund can get depends on the length of time you let the savings grow. The power of compounding works best over long periods of time. Hence, if you do not start saving for retirement the soonest, it will be more expensive and difficult to catch up later on. It is more viable to start planning for retirement as early as possible, unless you are contending with more serious financial pressures. Begin with setting aside a small amount of money every month and do it consistently.
For instance, Jen starts saving for retirement at 23. She makes $1,000 annual savings contributions for 10 years. Let’s presume there is a 15% constant annual growth rate. After 10 years, she already has $23,956. Come 20 years after, Jen earns $96,915.82.
Believe it or not, the magic of compounding works in taxes as well. We have previously discussed different investment accounts designed for retirement. We also advised to use government-sponsored investment accounts like IRAs. These accounts normally afford tax-deferred benefits.
Referring to the example above, let’s say the taxes are paid every year on all capital gains in the taxable account. There is a 15% annual growth rate and 20% capital gains tax rate. After 30 years, you will notice taxes leave the taxable investment size at around half that of the tax-deferred account. The bottom line: it is not beneficial to incur taxes sooner. So, take advantage of the tax-sheltering options or accrue more costs in the future.
The moment you start working, begin creating your retirement nest. Make use of available tax-sheltering or tax-deferring opportunities. Use the power of compounding to your advantage. If you intend to catch up later on, it will be detrimental to your finances.