In your 40s, retirement can seem a long way off. So saving for retirement can appear less important than taking care of other near-term expenditures. With retirement still potentially up to 25 years or so away, many people in their 40s often choose to prioritise other expenses, such as mortgage payments or their children’s education, over retirement saving.
Yet your 40s really is a critical period when it comes to saving for your later years. While it’s possible to salvage your retirement if you begin saving in your 50s, if you start in your 40s you’ll give yourself a much better shot at building up a large pension pot. Leave the saving until your 50s and it becomes much more of an uphill battle. Allow me to illustrate with an example.
Starting at 50
Let’s say we have two individuals, James and Charles, who are both saving for retirement and plan to retire at 68.
James has left his retirement saving a little late and, at 50, he finally begins putting away £500 per month into a diversified growth portfolio. Let’s assume his portfolio generates an annual return of 8% per year.
By the time James reaches 68, his retirement savings are likely to be worth around £225,000. Now obviously this kind of pension pot is a handy sum of money. Yet at the same time, it’s also probably not enough to live in luxury, given that a fairly standard lifestyle can cost in excess of £20,000 per year. James could potentially live for another 30 years after retiring and, therefore, £225,000 may not actually go that far.
Starting at 40
Now, let’s consider Charles. He’s a bit more switched on regarding retirement saving and decides to focus on building up his pension pot from age 40. Like James, Charles puts away £500 per month into a diversified growth portfolio generating a return of 8% per year until age 68.
By the time he reaches 68, his portfolio is likely to be worth around £572,000. Naturally, a retirement portfolio of that size could result in a more comfortable lifestyle. With that kind of lump sum, Charles could invest in dividends stocks and potentially generate dividends alone of over £30,000 per year.
Interestingly, both individuals were saving £500 per month and Charles only put away £60,000 more than James over the extra 10 years. Yet by 68, his portfolio was worth nearly £350,000 more than James’s. So, how did Charles end up with so much more money?
The power of compounding
Ultimately, the reason for his much larger retirement portfolio comes down to compounding which, in layman’s terms, means generating earnings on past earnings.
You see, when it comes to building wealth, compounding is one of the most important tools in an investor’s arsenal, because money that’s compounding grows exponentially. In other words, as money is continually compounded, the gains get larger and larger. Therefore, the longer money’s invested, the better.
And that’s why, if you’re in your 40s now, it’s time to think about your retirement savings sooner rather than later. Focus on building up your pension pot now, and you’ll give yourself a great shot at a comfortable retirement, and take the stress out of saving as you approach retirement. Leave it until your 50s, and retirement saving could be significantly more challenging.