PERSONAL FINANCE
Financial Independence: The Power Of Starting Early
You guessed it: compounding.
Financial independence isn’t a race, but who wouldn’t rather get there sooner?
Holding all else equal, it turns out that starting earlier — even if you can only put away small amounts — actually has exponential benefits decades down the road.
In fact, whatever your definition of financial independence, the most important factor is starting ASAP. Obviously, your saving and investment amounts and their rates of return matter immensely, but there’s no substitute for keeping time on your side.
Let’s explore a hypothetical example, that I wish I’d understood in my early twenties.
I’m not a financial professional. This is purely opinion and entertainment, not advice. Do what’s right for you, and if in doubt about what that is, then it’s important to find someone who’s legally able to tell you.
The power of time
Say John and Joe have the same education, jobs, family situations, student loans, and so forth. On paper, they’re the same person.
And they both understand that if you put $10,000/year into an index fund that returns around 7%/year, then you’ll reach $1 million in roughly 30 years. (That’s with monthly contributions and compounding, just to keep it simple.)
Right after college, John supplements his day job with occasional odd jobs and freelance work, while spending a couple extra years living with his parents. He does enjoy some hobbies and even travels a bit, but overall, it’s a pretty frugal standard of living. Consequently, he’s able to scrape together that $10,000/year starting at age 22. Even as John’s salary grows, we’ll assume it only replaces his side income, and he spends anything beyond that, so he never contributes a penny more than $10k/year.
But when Joe graduates, he moves into a cool but expensive apartment and decides to enjoy his twenties to the max. Consequently, he’s a bit tighter on cash, so he finally starts the same $10,000/year contribution at age 32, once his salary has caught up with lifestyle.
Now, the good news is they’ll both be fine. John will reach the million-dollar milestone around age 52, and Joe will reach it around age 62. Both should be able to retire just fine.
But here’s where things get interesting. When both gentlemen turn 52, John will have made an additional 10 years, or $100,000, of contributions. So you might think he’d be around $100,00 better off, right?
Not even close. In fact, he’s a whopping $582,537 better off at that point.
And that’s not all.
Perhaps John is tired of putting away money after three decades of diligence, and just wants to, let’s say, spoil his grandkids. So, while he doesn’t draw on his investments, neither does he contribute another penny after his 52nd birthday.
John’s assets just sit there while Joe keeps investing until they’re both 62. Of course, Joe does reach his own million-dollar threshold at that point, but John — who hasn’t contributed anything for the last decade — is up to an impressive $1,975,347 in total. To put it another way, Joe has enjoyed $971,181 of returns from nothing more than the passage of time.
This is the power of reinvestment and compounding in action!
At first, 7% annually on $10,000 was pocket change, but if you add that 7% to the $10,000, then another 7% to the that, and to that, and so forth…the numbers get strikingly large over the course of your life.
The farther into the future you extend this, the more that 7% is worth in absolute dollar terms. That’s why starting ASAP is essential. Remember, John and Joe both contributed the same annual amount for 30 years, but John began that 30-year stretch a decade sooner, and therefore enjoyed enormous absolute dollar returns even before he reached retirement age.
But what if Joe wanted to take his foot off the gas once he reached his fifties? In other words, once he’s 52, what would it take to catch up from not investing between 22 and 32?
He’d effectively have to nearly double his annual returns!
As much as I’d like to think I’ll double the market’s returns every single year for two decades…I won’t. Occasionally, sure, but not like clockwork.
Realistically, Joe’s only certain option is to work harder for longer in middle age just to offset the lack of savings early on.
This is a simplistic example, and so far, we’ve made a lot of assumptions and glossed over a lot of details. But, on a practical note, keep in mind that all of Joe’s “make-up” work probably takes a higher personal toll with children or aging parents or other personal priorities—most of which were less pressing (or nonexistent) in his twenties.
It’s not lost on me that being able to save that kind of money at any age is an enviable situation, and most definitely not the norm for the vast majority of the world. But the point isn’t the amount; it’s that time and compounding are intrinsically linked, so our early decisions play a disproportionate role (be it good or bad) in our financial trajectory.
Little things add up
Right out of college, I was lucky to pull in a couple hundred surplus dollars in a month, and it simply didn’t cross my mind as even worth putting anywhere but my savings account. (For a measly 1%, amid one of the greatest bull markets we’ve seen!)
I wasted years assuming I needed a large lump sum before it was even worth investing.
That was a poor choice on two levels.
First, I neglected the enormous role of time. A little money invested early is worth, well, a lot more invested later.
Second, because I ignored the importance of time, I didn’t think it was worth the effort of scraping together a bit more cash from side hustles. Investing (rather than simply saving) the occasional couple hundred I had available, then scraping together just a couple hundred a month more through simple and unglamorous tasks, would have left me tens of thousands better off right now.
I thought linearly, not exponentially. I was Joe, not John. But at least we live and learn.
There’s a simple lesson that I missed early on but have finally taken to heart:
Compounding is magic indeed…but it’s a slow sort of magic that reveals itself in five- or ten-year intervals, especially when you’re just getting started.
Steadily investing small amounts, augmented by even small side hustles and cost-of-living reductions, can expedite your financial independence by years.
Even though a dog-walking or junk-hauling business won’t grow into a massive conglomerate, it can help make you millionaire just the same.
In fact, over time, it’s practically inevitable.
