Save early, save often
10 February 2017 | Topical insights
Commentary by Robin Bowerman, head of marketing and communications for Vanguard in Australia.
One of the attributes of Australia's mandatory national retirement saving system is that it starts young adults saving for retirement as soon as they join the workforce.
Without compulsory contributions to their "superannuation" accounts, many millennials – aged in their twenties to thirties and also known as Generation Y – might well be reluctant to start saving so early in their working lives. That's understandable given that their retirement might be 40 years away, or more.
Because saving is required, our challenge in Australia isn't convincing young people to get started. It's convincing them that saving for the really long-term is really worthwhile.
A recent New York Times article notes that it's "perennially true" that young adults don't make retirement savings a priority. Whilst some of the 28-to-32-year-olds interviewed for the article are diligent savers, others aren't. Some recognise the need to get started but just haven't yet got around to it.
As the Times tellingly acknowledges, "millennials are in an ideal position to get started" because their seemingly modest savings have the opportunity to grow substantially over time. They're poised to reap the rewards of what's sometimes called "the magic of compounding" – that is, earning investment returns on top of past returns as well as on one's original capital. Compounded earnings can really mount over the long term – particularly when "long term" means 40 or 50 years.
My colleague Peter Westaway, PhD, who serves as Vanguard's chief economist for Europe, correctly points out that compounding is most effective when interest rates are high. Unfortunately, today's unusually low-interest-rate environment isn't conducive to spectacular results for bank savings accounts and other interest-bearing vehicles. The good news is that compounding still works quite nicely for investments in equities and other securities.
Ways to get the most out of compounding include:
- Save and invest as much as possible, as early in life as possible. Compounding needs plenty of time to produce best results.
- Invest regularly to keep building investment capital and thereby accelerate the benefits of compounding.
- Adhere to an appropriate long-term asset allocation for your portfolio, with appropriate exposure to growth-producing assets. (Learn more about this in Vanguard's Principles for Investing Success.)
A final thought on compounding: Disciplined retirement investors who reinvest their earnings automatically – rather than "cashing out" and spending the money along the way – are less likely to be distracted by alarming periods of market volatility and the ever-present din of investment commentary and advice from pundits and prognosticators. Investors who maintain perspective are content to let compounding work its "magic" without much interference.
As Peter Westaway noted, Albert Einstein called compounding the eighth wonder of the world, explaining that "he who understands it, earns it ... he who doesn't, pays it."
Take it from Dr Einstein: Save early, and save often. If you recognise the value of compounding at the beginning of your working career, you position yourself to enjoy its rewards at the end.
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