Every penny saved is a penny earned, right?
Well, that’s not really true. At least, not long-term anyway. Save money now, and you’re allowing yourself to make more money in the future.
I thought of this as I had a recent discussion with somebody just out of college, which means that person was a number of years younger than me by the way. Anyway, he was actually talking about saving money, which – as you could imagine – impressed me. Given his age, and his talk about saving, I thought about what a great opportunity this guy would have to grow net worth just if he applied sound personal finance principles right away.
At the age of 22, a person decided to think of opportunity costs, cut back on some extraneous expenses, and save an extra $1,000. He (or she) could do this by driving a less expensive car, cutting back on going out, living with Mom and Dad, or realizing that travel is overrated and often simply expensive entertainment (for many of us anyway). There are many ways one could save $1,000.
Let’s assume he managed to make such decisions to allow for an extra $1,000 to be saved each year for just 4 years from ages 22 to 25. Then, then the money was invested at a 7% annual rate of return (after accounting for inflation, considering the time value of money) and compounded/held until age 65.
The net result? He would have over $66,000 accumulated by the age of 65. Just for those annual $1,000 investments for 4 years, from ages 22-25. Not bad!
If the rate of return was improved, that figure could be even higher. Let’s say he took those 4 years of $1,000 investments, and hit it out of the park by earning a 10% rate of return adjusted for inflation. He would then have an extra $210,000 in today’s purchasing power by age 65, just for making a few smart decisions when younger.
While it’s clearly much, much better to start when young, those getting a late start can still benefit. If somebody starts at age 42 with these 4 years of $1,000 investments, and holds until 65, that 10% rate of return means over $31,000 by 65. If you multiply this out, one can see the value of compounding based on time and rate of return.
Again, it’s just a matter of making a few adjustments for a lot of people, deciphering wants versus needs, and having the discipline to follow through on a few adjustments. Really, the possibilities are exciting when you think about it!
My Questions for You
Do you ever think about trying to set aside incremental smaller amounts like this, and squirreling it away for the long-term?
Do you apply the opportunity cost concept, when thinking about spending money? In other words, if money is spent today, what it could become in the future if otherwise invested.
Have you thought about how powerful time and rate of return can be in terms of impacting your future net worth?