Automate Your Savings
How important is it to begin putting aside money for savings right now, as opposed to sometime later?
The following chart illustrates the effect of compound interest on savings over the course of 40-plus years. It shows that now is the time for saving.
The sooner you start to save, the greater the benefit of compound interest. Compound interest is the interest earned on reinvested interest, in addition to the original amount invested.
Here's an example: Two different individuals--Darryl and Cheryl, each 22 years old--have an extra $2,000 a year to invest or spend as they choose. Darryl opens an Individual Retirement Account (IRA) to start saving. Cheryl chooses to spend her $2,000.
In this example, Darryl's IRA earns 12% per year. Darryl saves $2,000 per year for six years, then never puts another cent into his IRA.
Cheryl spends her $2,000 per year for six years. After that time, she invests $2,000 per year until she is 65 years old. Cheryl earns the same 12% interest per year that Darryl does.
The chart below shows the value of Darryl's and Cheryl's respective IRAs, from the time they are 22 years old all the way to 65. Keep in mind, Darryl's total investment is $12,000 ($2,000 per year for the first six years), while Cheryl's is $74,000 ($2,000 per year for the last 37 years).
As you can see, with compound interest, the earlier you start saving, the greater the accumulated interest on your original investment. The important thing is to start saving your money. The best time to start saving is now--no matter how large or small the amount. It's never too late to start. Remember, today is the first day of the rest of your life, so get time on your side and plan for your future by starting to save--now.
Once you have three month reserves set aside in your savings account, set up an automatic investment plan.
This step is critical to helping you establish a true stable financial foundation and should carry you through your retirement. Choose a diversified mutual fund (any financial planner can help) to start your road to prosperity on. A diversified mutual fund will allow you to invest in many different companies that offer many different risks/return scenarios which will help protect your investment.
Next, set up a small, automatic monthly draft to take money out of your savings plan and deposit into the fund you chose. Have your bank set this up for you.
Now you have eliminated yourself from the equation. You have automatically set up a savings plan, depositing 10% of your paycheck into this cash reserve account, and now you set are automatically investing every month into a long term investment.
This last step is vital. You will never invest on a regular basis if you don’t set this up. Other needs will always pop up, but follow through on this. Your older self will love you, as you are financially independent and can comfortably enjoy your life.