There’s a philosophy that wisdom comes with experience. This is true in many areas of life, whether we’re talking about cooking or science or finance.
You can go ahead and spend years gaining the experience of others or you can draw on the experience of those who came before you. A chef can teach a sous (assistant) chef how to do a proper sauce reduction. Even elementary school physics students are introduced early on to the work of Isaac Newton. Why would you start from square one with your finances?
We reached out to retirees and those of retirement age to ask them a simple question: Looking back now, what financial advice would you give your younger self?
Compound Interest Is Key
The earlier you start putting money away for the future, the better. This makes sense because your money has more time to grow. However, once you understand compound interest, you really begin to see the power of time.
Timothy Wiedman is a retired associate professor of management and human resources from Doane University in Nebraska. When he was his students’ ages, however, retirement and savings were the last thing on his mind.
“I put off starting to save for retirement and didn’t open my first IRA until I was well over 31 years old,” he says. “And during my 20s, I also had a history of putting a fair amount of my discretionary funds into depreciating assets like used sports cars.”
Wiedman says that at the time, he always figured that he could catch up by putting away more money later in life, a decision he now views as unwise. To explain why, he provides an example.
“For example, if a 23 year old fresh out of college puts $3,000 per year into a Roth IRA that earns a 7.8% average annual return, 44 years later at retirement, that $132,000 of invested funds (i.e., $3,000 per year times 44 years) will have grown to $1,009,275,” Wiedman says. “On the other hand, starting the same Roth IRA 20 years later (investing in the same index funds) will yield very different results. Putting $5,500 per year (the current maximum for most folks) into that Roth IRA for 24 years still equals a total investment of $132,000 (i.e., $5,500 per year times 24 years). But at retirement, earning the same 7.8% average annual return, those funds will have only grown to $357,167. The delayed start will have cost that investor more than $652,000!”
Rule of 72
We’ve gone over compound interest, but how do you determine how fast your money is growing?
Ilene Davis is of retirement age. Despite this, she continues to do the work she loves as a certified financial planner. She recommends that all her young clients understand the Rule of 72.
The Rule of 72 states that you can figure out how fast your money will double if you divide 72 by the compound interest rate you’re getting. For example, if you invested $5,000 at a rate of 6%, you would have $10,000 in 12 years (72/6).
It’s worth noting that 72 works well as the constant for interest rates between 6%–10%. At higher interest rates, you would add one percentage point for every 3% the interest rate diverged from 8%, making it the rule of 73. On the other hand, for lower interest rates, you would subtract a percentage point for every 3% lower than 8%, or 71.
The Rule of 72 can also be used to determine how quickly you would halve your money if you didn’t invest it and failed to keep up with inflation. If inflation grew at a rate of 6% per year, that $5,000 would be only worth $2,500 within 12 years.
General Investment Tips
Davis also has several more general investment tips that she gives her young clients.
Be sure to set up a fund for emergencies. You don’t want an emergency to cause a financial setback years down the line because you had to dip into day-to-day funds or long-term investments too much.
She said to invest early and often. Even increments as small as $5 a day can help, just as long as you make it a habit to grow your savings and investments. As your income grows, you can increase your amount of savings.
Finally, protect the nest egg you have. Don’t spend just keep up with the Joneses. Buy what you need and not what other people expect you to have.
Millennials can’t go wrong following these sound tips. Do you have any financial advice to share with our readers? Let us know in the comments below.