What is the Advantage of Investing Early for Retirement?

When you’re in your 20s, retirement can seem so far away that it can be hard to justify saving. However, when you invest for retirement early, you have more time for investment income to compound and grow. You’ll be able to take advantage of a longer investment horizon to reach your retirement goals while using tax-advantaged accounts to grow greater wealth. Read on to learn what is the advantage of investing early for retirement.

What is Considered an Early Start for Building Your Retirement Fund?

It’s never too early or too late to start building your retirement fund. Generally, it's considered an early start if you start investing for retirement in your early 20s, although some parents start retirement funds for their children who have jobs. You can start investing even while paying off student loans.

The years fly by, and a $1 invested at age 20 with a 7% average rate of return would be worth $21 when you retire at the typical retirement age of 65. With the same average returns, if you can invest $1,000 a year in your 20s, that $10,000 (about $83 a month) will be worth about $168,000 when you’re 65. And that’s without continuing to invest until you're a retiree at 65.

If, instead, you maintain the same pace of investments, you’d have $305,000 by age 65. While that’s not enough to retire comfortably for most people, to get the same $305,000 starting at age 45, you’d need to invest over $600 a month. Starting early gives you a considerable headstart in wealth building and allows more time for growth.  

Top 5 Reasons to Start Investing Early for Retirement

Here are the top five reasons you should start investing for retirement early. 

Achieve Your Retirement Goal Faster 

Investment returns can lead to greater wealth over time. The more time you can leave money to compound, the greater the growth. Doing nothing else, a retirement account that’s been growing for 40 years will build more substantial wealth than a retirement account that is 20 years old, assuming comparable contributions.

Suppose you invest $100 a month in your 20s and then $500 a month from age 30 until retirement. With that plan, at a 7% average return, you’d have over $1 million by retirement at 65. Starting at age 45, you'd need to invest over $2,000 a month to reach the same level. 

Take Advantage of Retirement Plans

Retirement plans or pension plans offer distinct advantages. With a 401(k) or a traditional IRA, you can contribute pre-tax dollars to reduce your annual taxable income. Some employers offer contribution matches to a 401(k) as part of an employee benefits package, increasing your potential retirement savings.  

Traditional IRAs and 401(k) investment accounts can grow tax-free until you withdraw them. You’ll have to pay income tax on withdrawal, but this rate is often lower as most people have a lower income tax bracket in retirement.  

With Roth IRAs, you’ll deposit after-tax dollars into the account, but then they grow tax-free. That means if you put $6,500 a year in a Roth IRA, you can withdraw all earnings after retirement without paying taxes on that money. 

For example, if you invest $6,500 a year in a Roth IRA from age 25 to 65, assuming a 7% rate of return, you’d have nearly $1.3 million, of which only about $259,000 is contributions. That means you’ll earn $1 million tax-free. 

Secure Financial Freedom to Pursue All Your Interests

By investing early, you can create additional wealth and financial freedom. This process allows you to pursue other passions and interests without sacrificing them eventually when you retire. It also allows you to create a work-optional lifestyle or retire early with a more aggressive retirement savings and investing approach. 

Prepare Yourself to Withstand the Effects of Inflation

Inflation is an increase in the prices of goods and services in an economy over time. For example, a gallon of milk cost $2.48 in 1995 and $4.09 in 2022. That’s the effect of inflation over that 28-year period. 

Average inflation rates are 2% or 3% yearly, but some years are significantly higher. Strong retirement planning considers inflation and plans to stay ahead of inflation in monetary growth. 

You Have More Time to Build a Diversified Portfolio

When you start investing for retirement early, you can get to higher risk and reward investments offering higher growth potential. If you start investing later in life, you may not want to risk your capital. When you’re young, you can afford to take some risks, which could lead to greater portfolio growth and long-term wealth. 

How to Get Started Investing Early For Retirement in 5 Steps

It doesn't have to be complicated if you’re ready to start investing. Consider the five steps below to get started. 

1. Figure Out What Kind of Retirement You Want

Consider your current income and expenses. Do you want to maintain your current lifestyle, or are you willing to cut back? Do you envision a luxury, high-cost retirement lifestyle? 

To calculate your expected retirement expenses based on your desired lifestyle, consider expenses such as housing, healthcare, transportation, travel and daily living costs. It's important to be thorough and account for essential and discretionary expenses.

Once you figure out the types of retirement benefits you want to enjoy and the monthly cost of living, you'll be able to calculate how much you’ll need for retirement. Some investment advisers suggest aiming to replace 70% of your annual pre-retirement income, but if you’re young and just getting started, this figure could be significantly higher. 

2. Plan Your Retirement Horizon

Your retirement horizon is typically how much time you have until your retirement goal. If you’re 20, your retirement horizon could be 45 years or 20 years if you plan to retire early. How long you have to save and invest before retirement will determine your savings and investment strategy. 

Calculate how much you need to save to achieve your desired retirement lifestyle based on your retirement horizon, goals, and expenses. Consider inflation, investment returns and potential healthcare costs in the calculation. You can also use retirement calculators or seek assistance from a financial adviser to help with this calculation.

3. Determine Your Market Risk and Risk Tolerance

Assess your risk capacity, which is your ability to withstand potential losses without jeopardizing your financial well-being. Are you interested in aggressive, higher-risk investing that can potentially lead to greater wealth, or do you want to protect your capital? Factors such as your income, expenses, savings and other financial resources contribute to your risk capacity. Generally, individuals with higher incomes, larger savings and more stable financial situations may have a higher risk capacity.

Assess your risk tolerance, which is your emotional and psychological ability to handle market volatility and potential losses. Consider how comfortable you are with fluctuations in the value of your investments and your ability to stay invested during market downturns. Your risk tolerance is influenced by factors such as your personality, past experiences and overall financial temperament. 

If in doubt, consider consulting a financial adviser or investment professional. They can help you assess your risk tolerance, understand your investment options and develop an appropriate investment strategy that aligns with your goals and risk profile.

4. Allocate Funds from Your Budget

Once you know how much you want to save for retirement and how many years you have to save, you can work backward to calculate monthly retirement savings goals. For example, if you want to have $1 million in 20 years, assuming an average rate of return of 7%, you’d need to budget over $2,000 monthly for investment savings. If you’re starting at 20 and plan to retire at 65, you may only need to save about $300 a month. Use online calculators to consider different investment and retirement scenarios. Remember that a consistent return of 7% over 20 years is unlikely, so your plan may need to adjust based on the actual return you get from your investments.

5. Keep Your Expenses in Check

Discretionary spending is one of the main ways people undermine their retirement savings. To avoid this, regularly check in with your budget and total expenses. Weigh total expenses against retirement goals and see whether you can cut back. 

Remember that some discretionary spending is good. You’re more likely to stick with your retirement goals long-term if you can live a comfortable lifestyle right now. 

Wealth Management Starts Early

You're never too young to start creating a wealth management plan and saving for retirement. By learning about budgeting and investing, you'll be better prepared to work toward the financial future you envision. Whether you can put aside $10 a month or $2,000 a month, focusing on retirement savings early means you can create additional financial security or even a work-optional lifestyle. As part of your retirement planning, consider alternative investments or how to invest in stocks for beginners.

Frequently Asked Questions