Stumbled upon yet another article about the extreme power of compounding.
They use the following examples:
Let’s say Olivia saves £100 a month in to her pension from age 21 and stops at 30 - saving no more until she accesses the pot at age 70. We’ll say the pension earns a 7% return each year for this example. Olivia will have £282,325.
Oliver, meanwhile, doesn’t save anything until he is 31 and then saves £100 a month until he is 70. Olivier will have £262,481.
Yes, the human brain is not equipped to grasp compound interest.
In the same category, if i give you 10 seconds to choose between $700’000 now (proposition A), or $0.01 doubled every day for one month (30 days, proposition B), most people will choose instinctively A over B, without realizing that B is roughly worth $10 million.
Ironically, what you do in your twenties will have the greater impact for your late ages, and therefore carry the biggest opportunity cost. What’s funny (or dramatic, depending on the observer’s lense) is that the twenties are usually when people start earning money and thus want to finally buy stuff…
Let’s assume both Oliver and Olivia attend the same university, for the same degree, graduating with same grades and same employability (all things equal).
Hopefully Oliver focuses on his education and career in his 20s, rather than his savings.
If he manages to finish school or university just one semester earlier than Olivia (which might very well be possible by saving less) and enter the workforce a few, say six months earlier, he should, all other things equal, be able to quickly save a few thousands more than Olivia within half a year. A couple thousands more at 31 should quite make up for his non-saving in his 20s.
Also, keep in mind that one should discount the value of future savings contributions by interest or inflation rate as well. In layman’s terms: saving £100 at 70 years of age, 50 years in the future “hurts less” than saving £100 today. The present value of £100 in 50 years at a(n arbitrarily chosen ECB inflation target of) 2% rate of inflation is just approx. £37 in today’s GBP.
Though it is quite possible - if not likely - that we’re going to see periods of higher inflation within a span of 50 years. So the present value might be considerably lower. For instance, actually looking back at the last 50 years inflation in the Pound Sterling, the present value of today’s £100 (in 2019) was just slightly more than £6 (£6.13) in 1969.
A lot might then come down to sequence of returns. Even more so, if you’re saving now for 10 years and then wait another 40 years before withdrawal.
EDIT: Same web site as above gives an average rate of inflation of 5.75% over the last 50 years for the Pound Sterling.