The Importance of Building Savings Habits Early
We’re taught to save money from the time we get our first tooth fairy payment, but when we’re young, saving doesn’t always seem necessary. A common belief is that saving is for people who are getting ready to buy their own house, put their kids through college, or retire.
In reality, it’s better to start saving long before any of these things happen, for several reasons. (For related reading, see: How to Create an Effective Budget.)
Why Saving Money Early Is Key
First, it makes savings a habit. Take the tooth fairy profit, for example. The quarter a six-year-old saves from the dollar she found under her pillow isn’t going to fund her college tuition (a child only has so many teeth, you know). But having her tuck that little bit away in a savings account or piggy bank will get her into the habit of saving a little from everything she is given or earns in the future. The same goes for high schoolers and college students. Saving some of their summer job pay or internship income will prepare them for saving when they enter the work world full-time. Opening a Roth IRA sooner rather than later can be one of the best financial decisions that a young person can make.
Second, you may actually have more money now rather than later. A recent college grad just starting their full-time career or a young newly married couple may find this hard to believe, but they may have more expendable income now than they will in 10 or 20 years. Just as their income will most likely increase over the years, so will their expenses. Moving out of an apartment into a house increases maintenance and utility costs. Having kids not only adds expenses like additional food, clothing, and medical bills, but parents also often find themselves needing larger cars and more living space to accommodate their growing family. If both parents decide to keep working, they are likely to incur childcare costs; and if one of them leaves the workforce to parent full-time, that income is lost. (For related reading, see: 8 Essential Four-Letter Words for Financial Health.)
Lastly, it allows the power of compounding to work to its fullest. Starting to save as a child or young adult obviously gives you more time to save than if you wait until middle age. Investing this savings early allows compounding to work its magic. As an example, assuming a constant 6% annual rate of return, if a 25-year-old invests $10,000 a year for 10 years and then stops while a second person waits until age 35 to invest $10,000 a year for 10 years, the first person will have accumulated almost twice as much in total savings by the time they are both 45.*
So even if you aren’t planning on staying forever at your first full-time job right after graduation, participate in the company 401(k) plan as soon as you’re eligible. If there is a company match, invest enough to take full advantage of it. If and when you leave you can take it with you by rolling it over into an IRA which will allow your money to keep growing wherever you go. If your employer doesn’t offer a 401(k), you can still almost always save by payroll deduction to a separate retirement account. And the best part about saving through payroll deduction is that you won’t miss the money because it doesn’t appear in your bank account.
It’s important to pay yourself first – even before Uncle Sam, the landlord, the utility company, or the grocery store. There will always be money left for them, but there may not be for you if you don’t make this basic discipline a priority. Saving early will get you in the habit and give you a huge head start!
*This is a hypothetical example of mathematical compounding. It’s used for illustrative purposes only and is not intended to represent the past or future performance of any investment. Taxes and investment costs were not considered in this example. The results are not a guarantee of performance nor represent specific investment advice. Actual returns will fluctuate. Investments that offer the potential for high returns also carry a high degree of risk.