I am going to try to help you understand how saving early can have a pretty big impact on your financial health down the road with a simple example.
Imagine that there are 3 person, Mary, John and Tom. I know, I have no creativity, but bear with me.
They are all 25 years old. They all save $1000 a year and they all currently have $10,000 in their bank account. Let's assume that the interest earned from their respective banks are the same at 0.50%
Mary spends all her annual savings buying her favourite bags. Givenchy, Balenciaga, you name it, she buys it. (Okay, I know $1000 can't really get you those bags but assume she gets it on carousell or something.) She only realises that she better start saving after year 20 years, when she's 45 years old.
John is the kind of guy that doesn't spend on much now, he wants to save up for a big purchase in the future. Perhaps a nice watch, a down payment for a car or a great holiday getaway. He saves every year till he is 45 and starts spending all of them.
Tom on the other hand is a no nonsense guy, he saves every year without fail. He plans to retire comfortably and knows the importance of compounding. The goal is to be like Tom.
You can see that at the end of 40 years, Mary has the lowest amount of money. Even though she saves the same amount of money as John. The only difference is that she spends first then saves later, while john saves first then spends later.
Due to this tiny difference, John has about 7% more savings than Mary.
Tom's saving pattern is basically the combination of Mary's and John's. He saves for the first 20 and the next 20 years combined.
Tom has a whopping 70% more savings than Mary and 59% more than John.
And this is only at 0.5% interest rate. When the interest rates start going up, the difference between the savings amount will be amplified.
You can see a chart below to better help you see how their savings move with time.
I have attached the excel spreadsheet for you to experiment with it.
You can download the excel spreadsheet here
Feel free to change the:
- Initial Capital
- Interest Rates
- Individual Amount Saved
- Their names if you don't like them