While the second part seems obvious (but then, the challenge is in knowing how and where to invest smartly), most often the first essential thing to success - gaining early start advantage - is ignored. Analysis shows that if you start investing at age 22, say $500 each month, and get an annual return of 12%, you will make around $4.6 Million by the time you are sixty (click on chart for larger view). Compare that to the final amount of $3.25 Million if you start at age 25; and, the paltry sum of $1.82 Million if you start at age 30.
The advantage of starting early appears even more striking when observing that to finally catchup with age-22 start, you need to save and invest $1260 each month for the entire duration instead of just $500 if the start is made at age 30 (or $708 each month for the entire duration if start at 27).
It is also seen that, while it takes a staggering 25 years time after the start to reach the first million, it takes only six more years after that for the second million, and then just a little over three years to get the third million, and then less than two years for the fourth, and so on.
So, if you start late it is true that you are missing the initial years of aggregation; but most importantly you are missing the crucial last few years of significant acceleration. Most people, when started late, often think that they are behind by just $50,000 or so and can somehow make it up. But the wisdom lies in starting early to give enough time at the end, and let the aggregated money do the work for you rather than you working hard for the money.
If at all you have a question what difference it makes if you have $4 Million or $5 Million and why even make efforts to aggregate larger sums of money, I am sure the 99 others will not find it hard to convince you with their own valid arguments. Inflation is just one of my many views on it. Even with just 3% annual inflation rate, the $4.6 Million nominal amount accumulated by the time you are sixty is worth only $1.49 Million of real money (i.e., today's money) (see the chart). With 5% annual inflation rate, the nominal amount will be only $0.72 Million of real money. You don't want to end up living through the old age with a small amount of real money, after working hard the entire life, just because the inflation sucked the value out.
So, hurry up. Start now and beat the inflation. Of course, you can always beat the inflation by getting higher rate of returns (may be 14% or 15% or even higher) with smarter investing strategies. But, the higher returns are never guaranteed, involve higher risks, and are often not in your hands (remember, recent market collapse). The one thing that you can control is your start time, and so earlier the better.
There are many other early start advantages - some tangible and others not. For example, when investing it is necessary to experiment with small amounts at the begin and learn from the experience. An early start will give enough time to learn the tricks before it is too late. Also, any risks taken and losses incurred in early stages can be recovered with enough time later.
Also, it gets harder and harder to invest later in life as responsibilities grow. It is easier to save money and invest when you are young; you will be surprised how much money you will spend just on diapers later on!! And, even if you miss investing for a few years in second half of the period, it will not hurt as much as it does if the initial investments were missed.
For example, if you do not add any amount to your portfolio for five years during the age 46-50, you will still make $4.46 Million instead of the $4.6 Million; if not add during age 36-40 you will make $4.18 Million, and if not add during age 22-26 (that is start at 27) you will make $2.58 Million. The reason for such stark difference is that, as a critical mass of money is already aggregated and it is compounding itself, the smaller amounts you add to it in later years will make only a small difference. On the other hand, the money you add during the early years is a significant chunk of small sums in the portfolio.
Some points to note. Above numbers are for illustration of relative performance only. You can extrapolate that to any amounts you are capable of saving and investing. So, do your math for your own settings; the relation and inferences stay the same. Also, the above arguments need to be taken purely in a financial context; an argument for early start in saving and investing should not be construed as an argument against pursuing advanced degrees or other ventures. The above is only to argue for starting sooner than later. In fact the returns on investment in education, human relations, and the society tend to be highly valuable, and money is an essential component to make those other investments possible.
The above is not taught in any school or in any class -- somethings are realized just from analysis of one's own experiences as well as that of others. Next time, more on the power of higher rates of return, and how to catch those elusive higher returns while minimizing the risk through portfolio diversification (things that are taught at B-School).
