The power of investing early and how to catch up if you are a late starter

It pays to start investing as early as you can. More time in markets gives your capital a greater period to ride out market volatility and grow. Growth leads to more growth, that leads to more and more. This is called compound growth.

Your investment outcome is made up of a balance of contributions and growth. The earlier you start contributing, the less you will have to contribute. Given enough time, most of the growth will come from markets and compounding. Starting later means that more of the outcome needs to come from contributions.

The power of starting early

Let me explain this by way of example – to illustrate it simply, I have excluded the effects of inflation.

Imagine you start contributing R500 a month from the first month you start working and continue to do so for the next 40 years.

If you earn a return of 10 percent a year, you will have just over R3 million in 40 years’ time.

If you start 10 years later, you would need to contribute just under R1 400 a month for the next 30 years to accumulate the same R3 million.

If you only start saving another 10 years later than that – 20 years after you first start working - you would need to contribute R4 164 a month for the next 20 years to save R3 million.

If you start with 10 years left to achieve your goal, your required monthly contribution increases to R15 436.

The graph alongside illustrates what proportion of the targeted amount comes from contributions and what comes from growth over these periods and shows clearly how the sooner you start, the more you will earn in growth over time.

The longer you wait to start contributing, the more you will need to contribute each month.

If you give yourself 30 years instead of 40 to save R3 million, you will need to save almost three times more each month. If you want to save for just 20 years instead of 30, you will need to save three times more a month than what you needed to save for 30 years. When your time horizon is just 10 years instead of 20, you need almost four times more per month than you did to save the same amount over 20 years. Contributing over 10 years rather than 40 requires a monthly contribution 30 times more than the R500 a month you would need if you had the longer time horizon.

You should also remember the shorter the investment period, the higher the potential for short term loss and volatility. In short, it is much better to invest for longer to ride through the waves of volatility over multiple years.

How to supercharge your investments

If you really want to supercharge your investments, you should increase the amount you contribute a little every year. Every little bit counts, but an increase equal to the inflation rate or more is ideal.

Use every opportunity to top up your investments. Whenever you receive a lump sum from a bonus, inheritance or any other windfall, use at least part of it to make an addition to your portfolio.

There is a way even if you start late

It is much better to start making provision for your future as early as possible – choosing to start later has many risks and can put you under tremendous pressure.

If you have been dealt a difficult hand and are only starting to save later in life, you should be applauded for wanting to improve your future. It will take great discipline and sacrifice and will require a bit more luck in terms of the order or sequence of the returns you earn from your investments, but you can still make a massive difference.

Many years ago one of my clients went through a difficult divorce and essentially had to start saving from scratch with just 20 years until retirement. This person put a plan in place. They also worked incredibly hard, for which they were rewarded with good earnings and bonuses. They used the majority of their increases in earnings to contribute diligently to their retirement savings, maximising their contributions wherever they could.

Twenty years later as a result of their discipline, hard work and sacrifice they have more than enough to retire. The key to this was keeping their cost-of-living conservative. The higher your costs of living, the more you will need to accumulate in investments to replace those costs when you retire one day. A late starter who has high living costs is the least likely to succeed. This combination makes it very difficult to achieve financial freedom.

If you are a late starter, do what you can to cut back on your costs of living, keep them conservative over time and commit to contributing as much as possible each year until you reach retirement age.

The best time to start contributing toward your future is the first month you start working. The next best time is today.