People our age have too much on our hands. Studies, job-hunting, navigating office politics, relationships, the list goes on. So much so that we tend to ignore mundane and seemingly less urgent issues such as saving for retirement. In this article, we will explain why it is important to start saving early, and provide an illustration how to be a millionaire (in cash savings) when you retire.
Compounding
Albert Einstein is reputed to have called compound interest the eighth wonder of the world.
Compound interest is the eighth wonder of the world. He who understands it, earns it; he who doesn’t, pays it.
Attributed to Albert Einstein
Suppose a genie offered you a choice between one million dollars today; or one cent, with the promise that every day for the next one month, the genie will double the money. Which would you choose?
You can try to do the calculation on your phone. S$0.01, doubled 30 times, yields more than 10 million dollars.
That is the power of compounding. It works quietly and in mysterious ways, but with profound effects. One of those effects is to allow us to accumulate a large savings fund by setting aside small amounts regularly. But it only works will if we start early.
An illustration
We now provide an illustration to demonstrate why starting to save early is so important.
Suppose that a squirrel wants to accumulate S$1 million in savings by age 63 (which will be the new retirement age in Singapore in 2022). The squirrel is willing to set aside a fixed, constant sum of money as savings every year towards this goal. We will assume that the savings are put to work and garners a 5% Compound Annual Growth Rate, or CAGR (more on this in our next article).
How much will the squirrel have to put aside each year? This depends on the age at which the squirrel starts saving. We did some simple calculations in Excel.
| Early squirrel | Late squirrel | |
| Initial age | 20 | 35 |
| Annual return | 5% | 5% |
| Retirement age | 63 | 63 |
| Yearly saving required | $6,301.20 | $15,281.45 |
| Monthly saving required | $525.10 | $1,273.45 |
The early squirrel who starts saving at age 20 will only need to set aside S$6,301.20 per year for the 44 years over which it saves. This translates to $525.10 a month.
The late squirrel who starts saving only at age 35, on the other hand, will need to set aside S$15,281.45 per year for the 29 years over which it saves. This translates to $1,273.45 a month, more than twice that required if it had started at age 20.
What if the late squirrel, starting at age 35, copies what the early squirrel is doing and only sets aside S$6,301.20 per year? Then upon retirement at age 63, the late squirrel would have accumulated just S$412,932.22 (not even halfway to the goal of a million dollars).
We can plot the data on a chart to see how the savings accumulate.
We can see that the slope for the early squirrel is much gentler, corresponding to a lower monthly contribution (less than half of the late squirrel). On the other hand, the late squirrel’s line is very steep, as it has to catch up with the past 15 years missed out. This is why the late squirrel has to pay in more than twice as much each year.
The alert reader may be thinking: hold up, the late squirrel pays more every year, but only contributes for fewer years (29, instead of 44 for the early squirrel). Is the early squirrel really better off?
The early squirrel would have contributed a total of S$277,252.80 ($6301.20×44) between ages 20 and 63, while the late squirrel would have contributed a total of S$442,292.05 ($15,251.45×29) between ages 35 and 63. Clearly, the early squirrel comes out on top.
Squirrel says…
- Compounding over decades makes a huge difference towards your financial position at retirement.
- The best time to start saving was yesterday.
SG Squirrel 