Procrastination is a mysterious force that keeps many of us from completing the most important tasks in our lives. Often, we put off something we deem important simply because we believe it may not necessarily be urgent.
We know it is important to save for our future, but we typically underestimate the damaging effect of delaying this task. Most fail to realize the tremendous power of time and the impact it has on our ability to create wealth. We simply do not understand what’s at stake.
Ironically, for many, by the time they realize the power of time, it’s far too late in life to have meaningful impact on their financial well-being.
“Most people overestimate what they can do in a year and they underestimate what they can do in two or three decades.” – Tony Robbins
Let’s look at a couple of examples to illustrate.
The Value of $1 a day
If you saved and invested just $1 a day starting at the age of 25, how much money would you have by the time you’re 65?
The simple answer to the saving part is approximately $14,400 since that’s how much money would be in your piggy bank if you had just put a dollar in it every day for last 40 years (using a 30-day month for simplicity).
However, what if you had invested this money? For example, suppose you had:
- Saved $1/day for the past 40 years;
- Invested this savings at the end of each month ($30/month) in the entire US stock market (e.g., using an ultra-low cost US index fund);
- Re-invested all dividends and stayed the course through all of the ups and downs of the market.
When I challenged a group of students of a recent Financial Literacy Workshop with this question, the answers ranged from a low of $30,000 to a high of about $100,000.
It may surprise you to learn that over the past 40 years, the average compound annual rate of the Dow Jones Industrial Average Index, with dividends re-invested was just a bit over 12% .
Using this rate of return, the investment of $1/day would have resulted in a value of just under $300,000.
This is a great motivation to save. Most of us can afford to put aside $1/day. In fact, if we start early enough, chances are, we’ll increase our savings rate over the course of a 40-year saving/investing horizon and end up with much more money.
Now, just for fun, I challenged the same group of students to guess the value of the investment if, instead of saving $1/day over 40 years, the entire amount of $14,400 was invested on day 1. This time, the answers came back quite a bit more optimistic – ranging from $400,000 to $600,000.
The real answer is substantially higher!
Would you rather?
Here’s another example. If you could choose, would you rather
- Invest $50,000 and end up with $1,100,000; or
- Invest $125,000 and end up with $570,000?
It may surprise you that while everyone would choose option “A”, most people tend to act on option “B” (if they act at all).
To illustrate this with an example, let’s consider twins Charlotte and Louise.
- At age 25, Charlotte invests $5000/year for 10 years (total investment of $50,000). At an annual rate of return of 11% (slightly less than the example above), Charlotte would have $83,610 by the age of 35. Charlotte makes no more contributions but leaves her money invested at an average annual rate of return of 11% until she reaches the age of 60. At this point, Charlotte would have $1,135,881.
- Louise, on the other hand, procrastinates and does not begin investing until the age of 35 (when Charlotte stops her contributions). However, at age 35, Louise begins to invest $5000/year for the next 25 years – achieving the same 11%/year rate of return. Her total contribution over 25 years is $125,000. Sadly, at the age of 60, Louise would only have $572,062.
Despite contributing more than twice as much as her twin sister, Louise ends up with less than half of Charlotte’s portfolio value.
The above examples illustrate how easy it is to underestimate the power of time.
If we truly understand the magical power of compounding and its ability to create personal wealth, we would be motivated to save as soon as we start making money.