Why your first 10 years of saving could be more powerful than the next 40 combined
Vicki Owen
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For most people, their twenties is the decade in which they can least afford to save into a pension. It is a shame, because it's by far the most important one.
Believe it or not, those first ten years of saving can potentially be more powerful than the next four decades combined!
Here's a little tale of two savers that reveals the massive power of starting your pension early.
I've used calculators on Thisismoney to do calculations for "Oliver" and "Olivia".
Let's say Olivia saves £100 a month in to her pension from age 21 and stops at 30 - saving no more until she accesses the pot at age 70. We'll say the pension earns a 7% return each year for this example.
Using the "monthly savings plan" calculator; enter £100 monthly payment, duration 10 years and interest rate 7% and you get £17,308.48 - this is what her pot is worth at age 30. You then enter that figure into the "lump sum investments" calculator (duration 40 years at 7%).
Her savings will amount to £282,325.
Oliver, meanwhile, doesn't save anything until he is 31 and then saves £100 a month until he is 70.
Using the monthly payments calculator, enter £100 monthly payment, duration 40 years at 7%.
His pot will be worth £262,481. In other words, 10 years of saving have produced a pot £20,000 larger than four decades worth of saving the same amount each month.
This is due to the power of compound interest - or what you might call the returns on the returns on the returns.
The interest on Olivia's early saving has multiplied exponentially. By the time it gets to the fourth and fifth decades, it's worth many extra hundreds of pounds than Oliver can save through those decades.
This is of course an illustrative example and can not be relied upon when making any financial decision. If you are unsure as to the suitability of your investment speak to a financial adviser.
Another way to think of this is that if you put £1,000 into a savings account that pays 5% (we wish!), after five years it will not be just 25% or £250 bigger. This is because the first 5% also earns 5%, and so on.
It's tricky to work out even with a normal calculator, but there are various compound interest calculators online.
Using the "lump sum investments" calculator, enter £1,000 invested, duration five years, at 5% interest.
The answer here comes out at £1,283.36. So the return for the whole five years is 28.3% (£283.36) - and if you divide that by five you get an effective annual interest rate of more than 5.6%.
It's worth noting though that the higher the annual rate of return the more powerful the effect. If your pension pot is earning only 3% a year then early saving will not be equivalent to so many years' extra contributions. Likewise, if it's earning 10% then it will be worth many more years' extra savings.
As with all investments, the value goes up and down and you may not get back the amounts originally invested.
And of course, the idea is not to stop saving at 30 but keep going. Work on a savings plan to suit your needs.
There's a lot of people in that position wishing they'd known the power of compounding when they were 21.
View the original article on MoneyLens. MoneyLens is a website aimed at helping millennials manage their money.
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