- Investing is not just for the wealthy, and it is never too early or too late to start investing. If you ever plan to achieve financial independence (and who doesn’t), then the best time to start investing is today. Starting as early as possible is one of the biggest advantages there is when planning for your eventual financial freedom. Even if you were not able to start as early as you wished, you can still reach your goals if you commit now to a realistic plan.
- New investors might be hesitant or fearful to invest because of concerns about how the market is going to perform. The market’s performance over short-term time-horizons often includes the risk of market corrections, recessions, and periods of increased volatility. These risks are typical throughout history, and we cannot predict when they will occur. However, when you take on risk, in return for that risk, you may be rewarded with a return on your investment. Over the long-term we believe the market will continue to grow as economies all over the world continue to expand and more consumers have access to disposable income.
- Additionally, over a long-term time-horizon, investors must be careful to completely avoid the market and expose themselves to inflation. New investors also often have a long time-horizon for goals such as retirement, which allows them to better withstand any market fluctuations.
- When investors are able to contribute over a longer time-horizon, they may be able to take advantage of the strategy of dollar cost averaging. This strategy can reduce the volatility on purchases by spreading them out over time thus lessening the impact of market fluctuations.
- The amount you can save annually is important, but even if those first contributions are small, they become significantly larger over time through the power of compounding. The power of compounding is when you generate additional investment earnings from an investment’s previous earnings. This means that if you start with a small amount today, it can be the same as starting with a larger amount in the future.
Examples of the power of compounding and dollar cost averaging:
- Three investors (A, B, and C) who each save the same amount; $1,000/month over a 10 year period for a total investment of $120,000. The only difference between investors A, B, and C is the year when they start saving. Each investor earns the same average annual return (seven percent) consistently, until age 65.
- Starting early, Investor A saves $1,000 per month from age 25 until age 35. Investor A then stops contributing to the investment accounts, but the savings in the account are left to compound at a seven percent rate until Investor A reaches age 65.
- Investor B saves $1,000 per month from age 35 until age 45. Investor B then stops contributing to the investment accounts, but the savings in the account are left to compound at a seven percent rate until Investor B reaches age 65.
- Getting a later start, Investor C saves $1,000 per month from age 45 until age 55. Investor C then stops contributing to the investment accounts, but the savings in the account are left to compound at a seven percent rate until Investor C reaches age 65.
- Investor A reaches age 65 with investments worth $1,444,969.
- Investor B reaches age 65 with investments worth $734,549.
- Investor C reaches age 65 with investments worth $373,407.
- As the example demonstrates, the amount that you will need to save to fund your retirement can be dramatically lower if you start earlier. Additionally, focusing on investing early can afford you the option of not having to continue dedicating funding to your retirement later.
- While $1,000/month is a lot to save, an investor still receives the benefits of compounding if they invest at smaller amounts. Then, after starting to invest a small amount, the next challenge is to increase the amount you are saving.
- The amount you need to contribute to achieve your desired future savings can be reduced by using the correct type of account. By investing in a qualified retirement account or plan (such as a traditional Individual Retirement Account (IRA), a 401(k) plan, a 403(b) plan, or some other tax-advantaged plan), your savings are invested on a pre-tax basis meaning you get a tax deduction for contributing these funds. The money invested in these accounts will grow tax free, and you will not pay taxes until you withdraw the funds during your retirement. When you withdraw the funds in retirement, you may be in a lower tax bracket, resulting in potentially lower future tax burdens as well.
Disclosure: Foundational Financial Advisors, LLC does not offer tax preparation or tax planning services, but may provide references to accounting or tax service providers. Foundational Financial Advisors, LLC may also work with your independent tax advisor.