Final Step: Importance of Savings

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Probably the best benefit of budgeting is that you'll be able to have all of your routine bills planned for, and this will open up the opportunity to actually save money for the many important things your life.

The best lesson you can learn about saving money for any large expense (like having children, going to college, retirement, buying a house or car, or building up an "emergency fund")—is the power of compound interest. Even if you aren't at the "beginning" of your financial life, the importance of this lesson still stands.

"The best place to start is
where you are
with what you have."

Charles Schwab

The Time Value of Money, A Tale of Two Savers

To illustrate the power of compound interest, let's compare a hypothetical example of two savers—one who starts the process early, and the other who waits awhile.

The first person begins saving at age 21. She invests $100 every month for only ten years, and stops the process on her 31st birthday. At that point, her total investment is $12,000, and she lets it sit, earning interest, until retirement at age 65.

The second person waits until age 35 to begin saving for retirement. She also puts away $100 every month, but continues to do so up until age 65 (for 30 years!). So her total investment is $36,000. Like the first person, she never touches a penny of the investment until her retirement.

So who ends up with more money? Intuition might say that the second person, who invested more ($36,000 instead of $12,000) would end up ahead. But the earlier investor has time and compound interest on her side. Assuming an annual return of 8%, compounded monthly, the first investor would end up with $300,053, while the second would only have $150,030. In other words, the first person would invest $24,000 less than the second, but would end up with $150,023 more!

More Examples

Let's look at a few more examples to drive this point home.

Suppose that the first person, instead of stopping their investment at age 31, had continued investing $100 every month until retirement at age 65? There, her total investment of $52,800 would result in a nest egg of nearly a half million dollars: $489,120!

Let's pretend you just had a new baby, and wanted to ensure a golden retirement for her or him. When baby is born, you begin depositing $100 every month into an investment account. You continue to do that until the child's 6th birthday, at which point you stop. You leave the money in the account and never touch it. Again assuming the 8% interest rate, when the child retires at age 65, your investment of $7,200 would have grown to over a million dollars—$1,107,869!

Start Early, Save as Much as You Can

Naturally, these are hypothetical examples and the results of your own investments may earn more or less than the amounts given. Also, taxes will have to be paid either on the interest as it is earned, or, if the investments are in a tax-deferred account, when the money is withdrawn.

Those facts notwithstanding, this point is still worth noting... Starting today is better than starting tomorrow. Starting this week is better than starting next.

Aside from starting early, another major variable in the retirement savings process is the amount you save every month. Obviously, the more you put away, the larger your savings, and the faster your investment will grow.

Make "Savings" a Permanent Part of Your Budget

With a carefully constructed budget, you will have an excellent understanding of your monthly income and expenditures. That knowledge will translate directly into how much you can afford for your retirement savings. Meet with a financial or investment analyst, or the Personnel or Human Resources office at your place of employment, and begin your program. Make savings a permanent part of your budget. Years from now, you will be so glad you did!

The End: Thank you for taking this "tour" of budgeting with us!