This is an often asked and loaded question, a bit like asking how long is a piece of string, and the answer is “it depends….” It depends on a lot of factors including what your future goals and investment objectives are. Without delving into specifics there are a couple of principles worth exploring.
The first principle is saving today in order to spend tomorrow. We’ve all heard phases such as “saving for retirement” or “saving for a rainy day”, in other words saving now to spend later. In order to save, we need to spend less than we earn. For many of us this is easier said than done. There are always temptations in front of us. We often prefer to buy things that make us feel good now such as the latest mobile phone, the overseas trip or a flash new car rather than the things we need. We also struggle to find money to put aside and invest for tomorrow partly because we don’t get any instant gratification from doing so. This is a topic for another day!
We also live in a world where borrowing money is relatively cheap and we’ve become much more comfortable with taking on significant debt not only to buy houses but to also buy those big ticket items we want now. Just remember no matter how cheap it is to borrow, we still have to pay it back.
There will be a time when we stop working and need to rely on our savings to fund our lifestyle. The more we are able to save in the years we are employed and earning an income, the more money we will have to enjoy when we stop working. Naturally we want our hard earned savings to work for us so it’s worth more tomorrow than it is today.
This leads us to the second principle, the power of compounding investment returns. With compounding investment returns, you not only receive investment earnings on your original sum invested, you also receive investment earnings on the earnings you’ve accumulated. A simple example will explain this. If you have $100,000 to invest and you earn 6% per annum after tax and fees, you earn $6,000 in the first year. In year two, you have $106,000 invested and if you earn the same 6%, it accumulates to $112,360. Your investment earnings were $6,000 in the first year and then $6,360 in the second year. The additional $360 represents the earnings on the investment earnings from year 1. Over a longer time-frame this can make a significant difference as the table below illustrates.
In each of the 3 scenarios below, the assumed rate of return is 6%* per annum after tax and all fees and expenses. The difference in each scenario is the investing time-frame and the regular monthly contributions (i.e. savings)