The Benefit of Investing Early.
There is sometimes a temptation to postpone investing, particularly for younger investors considering to invest for retirement. After all, what’s another year or two spent living it up when retirement is so far off!
The illusion is that by waiting a year or two, we’re relinquishing relatively small returns.
Take Joe, who at age 22 has a spare $2000 and is considering investing in equities, the MSCI world index to be exact (which has returned 8.6% p.a. over the past 30 years). Joe’s friends tell say since ‘why not wait a few years and enjoy life a little more today’. After all, at 8.6% p.a. return on investment, over 3 years Joe’s only passing on $586.30. Peanuts, since one could likely earn more than that every week in an average salary job. Joe decides to live it up, and to tip in an extra $500 to his investments account when he hits 25 to make up the difference.
Big deal? Actually, for a little extra now, Joe just made a $20,000 decision.
It’s not the fact that Joe hasn’t got this extra $500 into an investment account. It’s that Joe has waited 3 years to start investing. This is because it’s not the first 3 years of investment income Joe’s giving up. It’s the final 3 years. And this is why time horizon is so important to keep in mind. If Joe had invested $2000 for retirement at age 25 rather than 22, the return on investment is $18,061.87 lower over the final 3 years.
Figure 1. Investment returns per year on $2000 @ 8.6%p.a. over 43 years (black bar far left is total return over the first three years, the three bars in red are the final 3 year returns!)
The numbers are even more startling when considering what could have been had Joe tipped in $200 every month until age 65 (from age 22), in addition to the $2000 initial investment. Joe’s mates might think he was skipping on $1625.81, the amount he’d gain after 3 years, but his final 3 years at age 65 are actually worth $264,694.10.
Figure 2. Investment returns on $2000 + 200/month @ 8.6% p.a. for 43 years. Black spec is total return over first 3 years ($1625.81), three red columns are the final 3 year returns (totalling $264,694.10).
This is one reason starting early is important. If you’ve got surplus cashflow, no or low high-interest debt and a decent emergency and/or reserve fund, then perhaps it’s time to consider investing. Historically, equities have been the strongest asset class during just about every long-term time period on record and if doing the leg work yourself isn’t a desirable use of time, there are many low cost index funds available for consideration (e.g. Vanguard Investments).