Early Savings Plans: The Turtle and the Hare
You have probably heard over and over again that one of the best ways to begin a disciplined savings program is to pay yourself first. If you haven’t yet been convinced of the wisdom of this strategy, consider two friends, Early Turtle and Late Hare, who take different approaches to saving.
Early, who feels he needs extra time to reach his objectives, believes in paying himself first and deposits $100 each month for 10 straight years into an account earning interest compounded monthly. After 10 years, Early stops making deposits and simply leaves the account to grow.
During these ten years, Early’s good friend Late, who tends to procrastinate but feels he can always make up for lost time, intends to save what’s “left over.” However, he spends everything and there is nothing left over to save. Finally, in the 11th year, Late decides that it’s “better late than never,” and begins making monthly deposits of $100 into a similar account. Late continues making deposits for the next 40 years.
The chart below shows the savings growth under two rates of return, 6% and 8%, compounded monthly. Let’s take a closer look to see who wins the race, the turtle or the hare.
Note: For illustrative purposes only. Examples are hypothetical and are not indicative of any particular investment.
At a 6% rate of return, Late ($100,452) finally edges ahead of Early ($98,698) in year 40. However, in those 40 years, Early’s total investment is only $12,000 ($100 per month for the first 10 years), while Late’s total investment is $36,000 (nothing for 10 years, $100 per month for the next 30 years).
With deposits earning an additional 2%, something dramatic happens: At an 8% rate of return, Late is still chasing Early after 50 years, despite the astonishing fact that Late’s total deposits ($48,000) are now four times as much as Early’s ($12,000)!
Even more startling is the fact that at 8%, the gap between Late and Early widens every year. At 8%, Late can continue depositing $100 per month for the rest of his life and will never catch up to Early!
The lesson is clear: If you want to get ahead, pay yourself first! Make time and compounding interest your chief allies.
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