Ah, Youth!

I wish I were the Benjamin Button of retirement planning. I wish I could start my career armed with a lifetime of knowledge and wisdom. But that’s just a fantasy. Like expecting Benjamin Button to win the best picture Oscar.

When you’re fresh out of school, starting on your career, you have two huge assets that you’ll never have again.

The first is time. It erodes. If you’re 25, you might have a 40-year working life ahead of you. But next year, you have 39 years to go. And so on. Not even Superman can stop that inevitable erosion. And time is very valuable indeed when it comes to retirement savings. Because time permits the financial markets to do most of the work of saving for your retirement. The less time you have, the more you have to save out of your own pocket at the expense of your current pleasure. Let’s face it. Foregoing spending part of your current earnings is hard work. Youth has the advantage of shifting more of the burden to the markets.

Here’s a simplified example. (Since today is Martin Luther King day, I'll use "Martin" as an example, in his honor.) Martin has a $50,000 salary. He begins saving at age 25, planning for retirement at age 65. Expecting no contribution from his employer (the cheapskates!), he calculates a reasonable saving percentage to be 8% of his salary. Over the course of his 40-year working career, and then a 35-year retirement, he projects that his contributions will account for only 2.67% of his aggregate distributions. Investment earnings will provide him with the other 97.33%. Thank you, financial markets!

But now imagine that Martin starts saving at age 40, with 25 years to go until retirement. Then Martin figures he will have to save a whopping 20% of his salary to build up a suitable retirement fund. His own contributions are projected to account for 6% of his aggregate distributions, essentially doubling the savings work he has to do, and reducing the contribution of the financial markets. (Caution: Don’t be scared. For the sake of simplicity, these two examples do not take into account Social Security benefits. Taking that into account would meaningfully reduce Martin's required savings percentage. I’ll address that in a later post.)

So the luxury of time and its effect on the miracle of compound interest is one valuable asset.

The second major asset only available to the young is the ability to set your standard of living. Imagine you are fresh out of college and starting your first job. Chances are they aren’t paying you a large salary, but whatever it is, it’s likely a whopping step up compared to the resources you had available to you as a student. And if you start putting aside 4%, 6%, 8%, whatever, of your salary, you won’t miss it. Your net take-home will still be a big step up from your student years. This is your first, maybe your last, and undoubtedly your best, opportunity to establish your standard of living. It may be the only time in your life you can begin saving and not suffer a drop in your standard of living. Taking that haircut won’t ever be this easy again.