Time is Money. Thus, time is another valuable resource often overlooked when it comes to another resource – money. So … let’s take a look at what this may translate to. This should be insightful for you – or your children, grandchildren, or any other person important to you too.
We like to spend as much as we can today. What is the cost of doing that for tomorrow? And why should you care?
Let’s say you would like to save $200 per month and starts at age 25. What would you have saved up by age 65? That is, over a 40 year period … and bear with me … you may not have 40 years to age 65 anymore. We’ll get to that next.
What you would save up is called Future Value. Let’s use a Future Value calculator. You can enter today’s date and then add 40 years to get the end date. Initial deposit is $200 since we’re assuming you’re just starting out for the purposes of this exercise and the point I want to make. I’ll enter 4% to be conservative for a return number.* The result is approximately $240,000 (I’m rounding to make my example math easier to see).
Now … you might be saying to yourself, I don’t have 40 years anymore! Let’s say you have 30 years (if less you’ll get the idea). The only change we’ll make to the calculator is to change the time. The result – about $138,000 is saved up. That’s a difference of $102,000! It now takes about $350 per month to catch up for that 10 year delay to get back to approximately $240,000. Delaying 20 years takes about $650 a month to catch up for a 20 year delay! The delays keep compounding!
Okay – so the temptation is to reach for a higher return. With 30 years left, and $200 a month, it takes 7% consistent returns* to make it up. That is almost double the risk. Relying on returns to make things up means you’re also setting yourself up for the downside of what happens with exponential natures of growth – in other words, most of the growth comes in the later years! Precisely those years just before retirement – and when you’ve relied on big returns to bail you out, here comes the larger market correction – the other side of the double-edged sword of returns called risk – and a lot of your value disappears with a market correction.
My point about returns reach temptations – better to rely on saving more money than risking it attempting to get returns – returns we may not get – but volatility in value we’re sure to get.
Let’s switch gears and look at what this may translate to for retirement income. This time we will use the concept of Present Value and a present value calculator. This assumes we have not reached age 65 (example retirement age), and what we have saved up is the present value we will consume over our retirement example of 30 years.
Set the date for 30 years. Future value is now $0 (or some “safety” or “bequest” number). Rate of return is our original 4%.*,# How much might $240,000 at age 65 provide for monthly income? Inputting different values until the Present Value is about $240,000, we get about $1,125 per month.# With that $138,000 from above, that’s about $650 a month.#
Your “Present Self” may want to spend as much as possible. However, your “Future Self” will be glad you saved – so you have money you can spend then!
*Note: because investing has returns that change, called volatility, the total sum of what you will have saved will be less. Here’s a great tutorial as to why (click through each segment for the complete picture for reason). Therefore, for calculators that assume a constant rate of return, it is best to understate the return input.
#Using the 4% rule: $240,000 * .04 = $9,600 / 12 = $800 per month; this is the effect of volatility of returns reducing what no-volatility calculators suggest. ($138,000 ~ $460 per month). Note the 4% rule is NOT a rate of return number, it is a safe withdrawal rate number (that happens to be the same value as my return number in this example) to aid in assuring you still have money in case you outlive the 30 years (instead of the value of zero you put in in the examples above)!