It’s graduation time – a chance for us to celebrate a key rite of passage for many young people. Often, our “go-to” gift is cash inside a greeting card.
This week’s MoneyDo: give a graduate – or anyone with their lifetime still largely in front of them – a longer-lasting gift, possibly with the cash: encourage and inform about the power of saving.
As financial planners we discuss many important financial concepts: tax planning, establishing retirement goals, defining budgets, and employing appropriate investment strategies. However, we consider the time value of money the most fundamental and powerful of all, and perhaps the easiest path to wealth later in life.
If you haven’t heard of the term “time value of money,” you may have heard of the concept, but not have known it had an actual name.
The time value of money is the concept that present money is worth more than the identical sum in the future because today’s money has potential earning capacity.
Let’s look at two hypothetical clients; Sarah and Jack.
Sarah starts his career at age 20 earning $60,000 a year.
- Sarah starts saving right way
- She invests $10,000 a year until age 30
- At age 30 Sarah decides to stop saving
- Sarah earns an 8% return on her balance every year
- Sarah has $1,457,000 available for retirement at age 60
Jack also starts his career at age 20 earning $60,000 a year
- Jack wasn’t taught the value of saving and opts against making contributions towards retirement
- At age 30 a friend explains to Jack the importance of savings and beginning to plan for retirement
- He begins to save $10,000 a year and does so for the next 30 years
- He also earns 8% every year
- At age 60 Jack has $1,132,000 available for retirement at age 60
At age 60, Sarah has $300,000 more available for retirement than Jack and she contributed only $100,000 of her earnings. Jack on the other hand, contributed $300,000 of his hard-earned money. All other assumptions being equal, Jack contributed 3 times more and has significantly less for retirement than Sarah.
No, not every graduate could make $60,000 a year, nor is eight percent an amount you or anyone should expect from your savings. We just used those figures to compare apples to apples. The point is that the money put aside today has potential to grow over time.
Share this lesson with your children as they graduate from high school and college this spring. We think it’s a powerful life lesson, that if instilled early, can make the path to wealth easier.