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Make saving a habit
In the early stages of your career money can often be rather scarce. Your monthly income just about covers your rent, food and a few small luxuries in the form of perhaps a daily Costa coffee. At this stage, you are unlikely to be putting much, if anything at all into your savings. This is often paired with the assumption that in the future you will be earning a greater income, at which point you can catch up on the missed savings time. Unfortunately, it doesn’t always work out this way, as people who get in the habit of not saving anything will often find it hard to shake that habit once their salary increases.
It does not matter if you are only putting away $20 per month, at the age of 21, the fact that you are saving something is the first and most important step. The easiest way to implement this strategy is through the ‘save first, spend second’ approach. As soon as you receive your salary, student loan or whatever stream of income you live off, move a portion you wish to save into a separate savings account. Some people use lock-in accounts to ensure they can’t be tempted to reach for the funds without giving prior notice.
The most important factor to consider for deciding whether to save and invest at an early age or not is the power of compound interest. Compound interest is an important concept to grasp. Compound interest makes a sum of money grow faster than simple interest. Simple interest is simply growth on an investment, for example, if you invest $1,000 and it grows by 8% your investment will be worth $1,080, the following year, if you achieve 8% once again on that investment your investment will grow to $1,166. You have received the same $80 on the original investment, but you have also gained 8% on the first year’s growth to the tune of $6. Adopting this approach from an early age allows investors to get well ahead. Compounding is sometimes known as the ‘snowball effect’ as the diagram illustrates.
The case study below demonstrates the power of compound interest.
Tom and Sally are twins.
Sally worked hard at a young age, Sally had a job at a pizza restaurant and also worked in a bank and was able to invest $2,000 per year from age 19-26. Sally then got bored of investing and forgot about her investment. Sally leaves the money in an investment account achieving 10% per-year until she turns 65. On Sally and Tom’s 65th birthday Sally looks in the account and to her amazement, she has $1,035,160.
Sally has invested $16,000 and now has $1,035,160. Sally is happy!
Her twin brother Tom went to a different college where he partied every weekend and did not think much about saving money. In fact, Tom decided not to invest until he turned 27. At this point, Tom had secured a good job and felt able to save. Tom decided he would try to make sure he had just as much as Sally for retirement, so he began putting away 2,000 per year all the way through until his 65th birthday. Tom used the same account as Sally and achieved 10% compound interest each year. After many years of investing Tom checked his account on his 65th birthday and to his surprise he only had $883,185.
Tom invested $76,000 and now has only $883,185. Tom is confused.
Sally has invested 60,000 less than Tom and now she has $151,975 more than Tom.
The power of compound interest allowed for Sally to enjoy a more comfortable retirement.
Be smart, be like Sally.
Planning for milestones and being ready to take opportunities in life
Many of life’s important milestones – getting married, moving into your first home, starting a family and preparing for life after work have one main thing in common, the requirement for financial planning. The better you prepare for these milestones financially, the greater the range of options available to you once you reach them.
Many of life’s hiccups require financial planning too, more in the form of protection. The age-old saying goes ‘save for a rainy day’, we recommend ‘getting insured for a rainy day’ too. Failure to plan for life’s uncertainties can mean whatever financial progress you have made in the form of savings etc, can be cancelled out if you are not insured for an emergency.
Life is very unpredictable; our career paths often end up being extremely different from what we planned aged 18. With that in mind, it’s important to be prepared for opportunities when they arise. This could be a business opportunity, a job offer in another country or an invention you want to peruse. Those who have started saving at an earlier age will have a greater chance of being able to take advantage of such opportunities in the future.
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