Saving a Little Early is Better than Saving a Lot Later

At the beginning of each year, a lot of people make resolutions. You might think it’s silly, but there is some basis for it. Even though it is just the start of another year, the New Year is a way to trick our brains. It’s an anchor in time.

Anchoring is a cognitive bias where you depend too heavily on an initial habit or behaviour, and make subsequent choices based on them. Once the anchor is set, all future choices are weighed against this anchor, making it easier to continue as you were.

2020 may have forced you to set new anchors. The lockdowns, job-losses, and general disruption to day to day life, many anchors in your life may have changed. I know some of mine have- some of which are not good for the long term- most notably the liquor cabinet is not as stocked as it once uses to be. So the New Year is a great time to set a new anchor- or as it’s sometimes called, new years resolution.

A common new years resolution is to invest more, to save more, or to spend less. If this is your goal, then New Years is as good of a time as any to start. A new baseline in your behaviour to start the new year with. And when it comes to saving and investing- you can never start too early!

Why it makes sense to start saving early

Time is on your side when you are younger, which is why you should start saving, even if its a small amount. The returns from compounding will have the biggest effect if you start early.

Let us consider two investing/saving situations. In both cases, we’ll assume that you can get an 8% return for simplicity sake.

  1. You start saving in your 20’s, saving $100 per month for the next 10 years, until your in your 30’s. You may have decided to start a family at this stage or buy a house. Either way, your disposable income has decreased somewhat as your living expenses and responsibilities have increased.
  2. You start saving in your 40’s and invest $500 per month for the next 10 years. You’ve spent most of your 30’s paying down the mortgage, and now with a few pay increases your disposable income has increased

In which situation would you end up with more? $100 per month for 10 years starting in your 20s, or $500 per month for 10 years starting in your 40’s.

In situation 1, you have only invested $13,200- in the same ballpark of the amount of money the average Kiwi spends on a car every year. Compared to in situation 2, you have invested $60,000, more than 4 times as much.

By the time you are in your 60’s- you will be slightly better off with the $13,200 investment, with $230,000 compared to the $60,000 investment that has grown to $219,000.

The reason why a $13,200 investment over 40 years can achieve the same return as a $60,000 investment over 20 years is compound returns. It’s easy to see the difference when you graph each situation. Here’s situation 1;

And here’s Situation 2;

You can see that Situation 1 is exponential, whereas Situation 2 looks quite linear. What I mean by that is that Situation 2 is growing in what looks like a straight line, and Situation 2 is growing faster than a straight line- it’s exponential growth.

It’s not that there is no exponential growth in Situation 2- it’s that there hasn’t been enough time for exponential growth to take over.

Why it’s not good to put off retirement savings

It pays to invest early to allow compound interest to kick in. The same is true with joining and contributing to KiwiSaver (and not raid your KiwiSaver for a house deposit).

I made the mistake of joining KiwiSaver late (Kiwi-Investor as I like to think of it) in my late 20’s. I thought that I could use the extra money to pay my mortgage or invest outside Kiwisaver- in hindsight I wished I had joined earlier.

Let’s say you want to save $500,000 to retire with. If you use 4% rule, that will give you around $20,000 per year to spend in retirement, plus NZ supper once you are 65. How much will you need to save per month assuming a 5% return starting at age 20, 30, 40, 50, and 60?

  • Start at Age 20 – $246 per month.
  • Start at Age 30 – $440 per month.
  • Start at Age 40 – $839 per month.
  • Start at Age 50 – $1870 per month.
  • Start at Age 60 – $7352 per month.

The monthly saving rate doubles every decade.

If you are going to be relying on Kiwisaver for your retirement, and you want to hit $500,000- you may not be contributing enough. The median income in New Zealand is about $25,50 per hour as of mid-2020 ($53,040 per annum based on a 40-hour week).

At a 3% contribution to Kiwisaver- you will be investing around $130 from your salary and your employer will be contributing around $100- giving you a total of $230 per month. Depending on your age- this may or may not be enough to reach your goal. Have a look at the calculator on sorted to get a better idea.

We’re Bad Savers- Let’s Change that

But Let’s face it. New Zealanders are not good savers. In fact, we’re one of the worst in the OECD. Our savings rate has been negative for much of the last 20 years. We have been borrowing money to fund our lifestyles for a long time- and I don’t think the statistics will be any better for the last few years either- especially with everyone trying to jump into the housing market for fear of missing out.

So as we head into 2021, and say good riddance to 2020, I encourage you to have a look into saving and investing for your future. Even if it’s only a small amount, as they say- the best time to start saving and investing is 20 years ago, and the second-best time is today.


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