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Investment Fundamental #10 – Start Early

by retirebyforty on January 28, 2011 · 63 comments

in retireby40's investing fundamentals

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start early invest

Baby is T-minus 3 weeks, so I’ll need to wrap up my 10 investment fundamentals and write a big “How I will Retire By 40″ post before things get hectic. My #10 is to start investing as early as you can. This is one of the most important rule of investing. When you start investing early, time is on your side and your investment have more time to grow with compound investing.

Compound Investing

Compound investing is the best thing since chocolate cake because every year your gain from the previous year will become the base line for this year. If you invest $10,000 in 2010 and had 10% gain, then you would make $1,000. So in 2011 you will start with $11,000. If you have the same 10% gain in 2011 then this year’s profit will be $1,100. Every year you will make more and more money. As you all know, our time on Earth is limited so the earlier you start, the more you will have when you stop working.

Let’s look at some hypothetical examples.

Joe starts working at age 20 and invested 10k per year right away. We’ll assume 10% gain to make it simple. In 20 years, he stops investing, but he won’t withdraw the money until he completely retires at 68. He will have $3,351,214 in his investment account when he is 68.

Michelle starts working at age 20 and spends a lot of money on clothes, shoes and purses. She wises up and starts contributing to retirement at age 30 and invests 10k per year for 20 years until she is 50 and then stops. In this case, she will have $1,625,989 when she retires at 68.

start early invest graph

They both invested 200k, but do you see the huge difference in the amount accrued at age 68? Even if Michelle keeps investing 10k/year for another 10 years until she is 60, she will only build up her account to $1,860,696. This is because Joe had a 10-year head start on her at the beginning of the race.

Kevin @thousandaire.com made a great retirement calculator. You can check it out and plug in different numbers to see what your retirement may look like. That’s what I used to calculate the numbers above, so if there is any mistake it’s Kevin’s fault. ;) He also made a video showing how you can have $1M when you retire.

OK, I see this calculator is not quite perfect. Michelle’s 10k investment should be adjusted for inflation somehow, but her account still won’t catch up with Joe’s account even with that. Kevin also shows two columns for tax advantage vs post tax account. It’s startling to see how much difference there are in the two. Another lesson learned – put off paying tax as long as you can.

Start Early

In my case, my dad insisted that I contribute to the 401k when I started working. I wrote a guest post about this and it is up at Budgeting in the Fun Stuff if you haven’t seen it – The Best Financial Advice I Ever Received. Thanks to my dad, my 401k account is in good shape and I may be able to retire early.

Remember – Nobody thinks about quitting when they start a new career so they don’t think about retirement. When we’re young, we just want to spend the money, but think how much you are taking away from your future self. So start saving for retirement as soon as you can and future you will be that much happier.

ps. I will max out 529 for baby while I’m still working these next few years to get him started early. Once I stop working, we probably can’t contribute to 529 as much. BTW, isn’t technology AMAZING? I didn’t even know they can do this. The ultrasound technician pushed a button and we can see him smile and frown, so awesome!

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{ 56 comments… read them below or add one }

LifeAndMyFinances January 28, 2011 at 4:09 am

Starting early is key to getting that compound interest rolling! My wife and I have started our retirement funds. While we didn’t start super early, she was only 22, and I was 25, so we’re doing better than most I would assume!

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retirebyforty January 28, 2011 at 8:39 am

I think you’re way ahead if you started in your 20s. We always read about people in their 50s with no saving and I think wow, they’ll have to work at Walmart.

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Everyday Tips January 28, 2011 at 6:34 am

We started our retirement funds when we got our first paycheck at the age of 23. (We got married a week after graduation.) I wish the market had performed better over those 20 years, but I am so glad we invested back then.

Have you decided which state you will use for your 529?

I can’t believe how much better ultrasound pictures are now than when I had my last one 13 years ago. The 3D imagery in phenomenal.

Be ready, that baby might decide to come out any minute!!

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retirebyforty January 28, 2011 at 8:42 am

I did the same! The Mrs. got started a few years later and had a couple of non contributing years, but her account is catching up to mine.

I also wish the market had performed better, but I think we are still better off than many more people.

I heard baby might come any minute, I’m ready! Well, not really I still have to pack a bag, but the Mrs. is ready.

We probably will use Oregon’s 529, but I heard good things about Utah. I will need to do more research.

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Jessica07 January 28, 2011 at 6:49 am

Great post. Great, great, great post. *applauding wildly* I think you should make this fundamental #1. :)

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retirebyforty January 28, 2011 at 8:43 am

I’ll post #1 next week and it’s even more important. :)

The picture is really great, I love it. He looks just like me BTW. :)

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Jessica07 January 28, 2011 at 6:51 am

By the way, thanks for posting the picture. I want one. :(

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Kevin @ Thousandaire.com January 28, 2011 at 6:58 am

Congratulations on the baby!

And you hit the nail on the head with saving early. Compound interest is the best thing in the world when you have enough time to let it grow. (unless we’re talking about inflation)

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retirebyforty January 28, 2011 at 8:46 am

Thanks for making the spreadsheet. It’s really helpful see my plan. All the retirement calculator I’ve seen does not support stopping contribution at 40. :)

I also realized why compound interest is the best. It’s because we have a limited time to live. If we live forever, we can always compound later. However, we only live for a limited time so it is essential to start as early as possible.

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lovely leverage January 28, 2011 at 8:35 am

OMG a baby! Congratulations, I am so happy for you! :)

I totally agree with you “put off paying tax as long as you can”. Taxes is one of things that keeps the poor from the rich.

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retirebyforty January 28, 2011 at 8:47 am

Thanks! We have to do what we can to avoid paying tax right?

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Marc January 28, 2011 at 9:07 am

Great picture! We didn’t get a 3-D ultrasound with either of our kids as my wife feels they are a bit creepy. I had a 401K that I started while working for a tech company in the .com era but I have had to cash it in (I know bad move) due to circumstances that came our way.

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retirebyforty January 28, 2011 at 2:07 pm

Thanks! I need to read up on how this work. I guess it’s just surface mapping, but it is so cool.
It’s incredible that we can see him moving around and he got all cranky after being poked with the ultrasound device.
Yeah, life gets in the way of saving sometime.

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Buck Inspire January 28, 2011 at 9:41 am

I think all schools should stress this fundamental rule of start saving for retirement early. Compounding interest sounded Greek to me, but looking back, really should have taken more advantage of time. Congrats on the baby on the way. Exciting! :)

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retirebyforty January 28, 2011 at 2:07 pm

Thanks! I didn’t understand compound interest either. I thought you can just start compounding anytime. The problem is we have limited time to work and invest.

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Clay Ivy Finance January 29, 2011 at 10:25 am

You are so right. The schools have to do a better job of financial education. The earlier you start understanding money, the better off you will be.

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Aloysa January 28, 2011 at 10:20 am

I started contributing when I got my first real job in the US. I think I was 27-28. And I could contribute a lot because my salary was miserable. :-) But as soon as I got a decent job, my contributions increased. I love to see it grow (when it actually grows). I do have a friend who is in this country longer than me and STILL doesn’t have a retirement account.

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retirebyforty January 28, 2011 at 2:09 pm

This last 10 years had been really tough for stock investors. Hopefully the next 10 years will be better!
I think you’re still better off than a lot of people because you already started. I would guess most people only start investing in their 30s.

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BeatingTheIndex January 28, 2011 at 1:25 pm

Not everyone is able to start contributing early because many people in their 20s are riddled with student loans. Even without any loans, salaries are meager when one first starts a career which makes it very hard to save substantial amounts!

Unfortunately, I only started in my early 30s, but better late then never!

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retirebyforty January 28, 2011 at 2:10 pm

That’s my brother. He is already early 30s, just finished school and has student loans. I think as long as you are saving something, it’s still a lot better than most people.

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The Passive Income Earner January 28, 2011 at 2:54 pm

I agree that starting early is key as it builds the proper saving behavior and you have it for the rest of your life. As soon as I started working I started saving. The key is to not get caught up in life style inflation :)

I believe it’s a 2 step approach though, the compound growth is not that easy and 10% is an insanely large number to achieve. 3 years ago I readjusted my investing philosophy because I wasn’t getting the compound growth I wanted even though I was saving and investing.

The compound growth isn’t as easy and to beat inflation (or at least keep up with it) you need at least 3%.

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retirebyforty January 28, 2011 at 3:36 pm

10% is Kevin’s number. :)
I would be happy with consistent 8%.

What is your 2 steps approach? Can you share? I know you like dividend stocks. My approach will be about 50/50 rental/stock market.
I agree compound growth is not that easy especially over these past 10 years. The dot com bubble and the great recession did a number on everybody’s accounts.

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The Passive Income Earner January 28, 2011 at 6:02 pm

I meant that first you need to save and start early. Then you work on making your money work.

The theory of compound growth is awesome, but it’s hard to execute in practice. Back in the 80’s, my parents had interest in the 10%-15% so it was easy but these days you have to work hard to execute compound growth.

I am like you, I want to do rental and dividend stocks. Rental is hard in Vancouver though, I’ll need to go out of town.

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Deidre @ TransFormX January 28, 2011 at 3:05 pm

What a great picture & post :)

I saved my son’s ultrasound and its in the front of his 1st year baby book. Very cool to look back on it all….he’s 21 this year.

I save very well but should look into some options for 401K which will help. Since I am self employed that may impact things dramatically.

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retirebyforty January 29, 2011 at 11:47 am

I like 401k for the matching and the pre-tax advantage. We’ll definitely save the ultrasound pictures.

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Deidre @ TransFormX January 29, 2011 at 9:35 pm

Hmmmm I guess I could match myself huh? :) @ 401K
Actually, I think there is another name for retirement funds for self employed folks. I need to check ING out.

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retirebyforty January 30, 2011 at 7:22 am

Unfortunately, I don’t know much about self employment. I think it’s 403 or something like that. You probably need to talk to a real investment firm like Vanguard. Maybe some discount broker has that service too.

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krantcents January 28, 2011 at 8:28 pm

This is one of those situations where youth is wasted on the young. Most young people do not want think about retirement in their twenties, maybe the best compromise is investing in a Roth IRA. It has less restrictions and can be used to buy your first home. Maybe another compromise is to think of investing in a 401K as a tax subsidized investment. For the price of a lunch, you can have millions in 35 years!

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retirebyforty January 29, 2011 at 11:48 am

Right, who wants to think about retirement in their 20s. :)
I’ll make the kid contribute to retirement with his first pay check too.

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Suba January 28, 2011 at 10:31 pm

We didn’t start saving for retirement until a couple of yrs ago (we are almost 30 now), but in our defense we didn’t start earning until we were 25. So luckily we wasted only 2 earning years before we wised up. For us the market has been phenomenal. We started putting money away in 2007, market crashed in 2008, which is when we upped the contribution like crazy (not timing the market, just decided to take the plunge and do it). So essentially we bought a lot on “sale”. We are not counting on those, how many more market swings we will have to see before we retire, but it is nice to see the balance. Hopefully we can catch up inspite of starting a little late.

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retirebyforty January 29, 2011 at 11:49 am

You guys still started in your 20s right? That’s a lot better than most people and you still have many years left to invest. We kept contributing through the dip as well and it worked out OK. Our portfolio has mostly recovered. It could have been a lot worse if we stop investing and pulled out the last few years.

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101 Centavos January 29, 2011 at 6:49 am

I’d say that most readers and commenters are veteran or newly-converted savers. The majority of North Americans are not — hence the abysmally low national savings rate.
No doubt that starting early yields higher returns through compounding. But for many who financially illiterate or in dire, paycheck-to-paycheck situations, contributing to a 401K or TFSA is often a “next month” resolution.

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retirebyforty January 29, 2011 at 11:51 am

You’re right about the saving rate that’s for sure. I think most of the readers of personal finance sites are making positive progress and are way ahead of the average.

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Clay Ivy Finance January 29, 2011 at 10:23 am

Warren Buffett said one of the greatest factors to his success was that he started early. Buffett filed his first tax return at the age of 13 taking as $35 deduction for the bike he used to deliver papers. For those of you who are young, start now. For those of you who are older, it is never to late to start.

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retirebyforty January 29, 2011 at 11:52 am

Wow! He must have had great advisors at 13. I didn’t know anything about deduction until College.

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Evan January 29, 2011 at 1:21 pm

Congrats on the new one coming! Ummm did you sign up for a Pregnancy Pool yet (cough cough lol). When you say max out your 529 do you mean up to gifting limits or do you mean up to your state’s deduction limits?

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retirebyforty January 29, 2011 at 8:35 pm

Thanks! I didn’t even think about the Pregnancy Pool. I’ll let the Mrs. know.
I meant up to the deduction limit on the 529. That’s $4,000 in Oregon so we’ll have to set it up after he gets his id.

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Cowtown Realist January 29, 2011 at 10:42 pm

Your Dad is a smart man. I wish I would have listened to my Dad when he told me to contribute to my RRSP when I was a teenager…

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retirebyforty January 30, 2011 at 7:23 am

He is very smart, but unfortunately this is one of those do as I say and not as I do thing. The state of his retirement saving is not good.

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Yakezie January 29, 2011 at 11:26 pm

I wonder if many people do in fact start early and ever reach those lofty numbers though? Or, do they just get shallacked after a downturn, panic, sell, and never get there?

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retirebyforty January 30, 2011 at 7:26 am

I will ask my friends and see what they do. One guy pretty much quit the stock market and is investing in real estate. Another gal also complain that the market never did her any good so she probably doesn’t have much in the market either.
The problem with starting early is you don’t know what you’re doing early. Unless you’re in finance or have a good adviser.

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Clay Ivy Finance January 31, 2011 at 4:44 pm

People in this situation may be best advised to contribute to a market index fund. If you don’t know what you are doing, take market returns rather than trying to pick indivdual winners. Over long periods of time the overall market return will serve you well. I would suggest this before ever considering owning real estate. If you don’t know what you are doing real estate is tougher. Liability, repairs, and dealing with people come into play much more with property than with stocks.

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Lisa @ Cents To Save January 30, 2011 at 7:05 am

Congratulations on the new arrival! I wish I listened to my dad when he said don’t use your credit cards and only pay the minimum. Live and learn… live and learn :)

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retirebyforty January 30, 2011 at 7:27 am

Thanks! It’s always difficult to listen to parents right. ;)

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Moneycone January 30, 2011 at 10:10 am

When Google went public, the first thing Google did was hire the best brains from the financial industry to educate Google employees about what they are about to receive and how best to manage the new found wealth.

I wish more companies did that. Atleast for fresh graduates on their first job.

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retirebyforty January 31, 2011 at 9:14 am

It would have been great if I had more finance education when I first started investing. We would be in much better shape if I had good advisers. Oh well, experience is the best teacher.

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Roshawn @ Watson Inc January 31, 2011 at 3:23 am

First, let me say congratulations!!!!

I do agree that the magic of compounding interest is still mind-boggling yet so very simple. I do agree that people certainly need to put themselves in a position so that retirement is not a struggle, and the earlier one starts, the less work they have to do. Investing in tax-advantaged accounts dramatically increases the odds of retiring comfortably.

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retirebyforty January 31, 2011 at 9:17 am

Thanks!!!
The tax advantage angle is very easy to overlooked. The calculator really shows a huge difference between taxed and pre taxed account.

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Squirrelers February 1, 2011 at 11:52 am

Big Congrats on baby!

Also, I agree that compounding and starting early make a great tandem. Let math work in your favor, and don’t procrastinate. Just get started. It really makes a big difference to be action-oriented in this realm.

One addition – important to consider present value here, as a dollar today is worth more than a dollar tomorrow (unless deflation kicks in).

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retirebyforty February 1, 2011 at 3:16 pm

Thank you!
Can’t argue with math. :)
Yeap, inflation is very sneaky.

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Sandy @ yesiamcheap February 1, 2011 at 1:06 pm

Okay a couple of things here. I get the invest early thing. I started my first 401K at 19! It wasn’t much but it adds up over time. :)

Second thing is that most 20 year olds don’t have 10K to invest. Sorry, it’s the truth.

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retirebyforty February 1, 2011 at 3:15 pm

That’s the problem with starting early. You don’t have any money and you don’t have enough investment experience. I wish I had a great finance adviser, but I guess we are doing ok.

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Finanzas Personales February 2, 2011 at 5:05 pm

This should be # 1. Not only because it’s an important one, but because it’s so easy to apply!!! However, young people are usually driven to spending much more than they can afford and, by the time they realize the power of compound interest, they first have to pay the debts they took and then start. Lots of time wasted!!!

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retirebyforty February 2, 2011 at 10:16 pm

When I first started, I concentrated more on the specific accounts type like 401k and Roth. Starting early should definitely be in the top 3!

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Eric October 24, 2013 at 5:06 am

Our kids make little bits of wages with their summer and part time jobs, and we’ve been matching it with Roth contributions for them. We’ll probably continue that all the way through college for them until they get real jobs.
A solid start on a Roth at that age, left to grow for 40 years, should be huge for them down the road.
You see those comparisons all the time, where someone contributed for 5 years and stops, as compared to someone who waits for 5 years and then contributes for the rest of their life, and yet the one that waited never catches up. That’s the idea.

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retirebyforty October 24, 2013 at 11:30 pm

I’m planning to do that too. 40-50 years growth would be something to see.

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