Last week I had the opportunity to speak to some students about the value of saving early. After the presentation, I started to think about it and realized that saving early is the single most important component to generating wealth.
As I’ve talked about before, companies will only pay you what they have to in order to maintain internal equity. As such, I’ve advocated maximizing your earnings as early as you possibly can (this is easier said than done, but if1. I believe there are situations where it makes sense to leave money on the table, but as you’ll see in the charts below it’s *critical* to step into a role where you can make up the money *very* quickly… you’d better be sure you can recoup the earnings or it will be the most expensive choice you ever make.you understand your market value it *is* possible). 1
With that said, even if you don’t make a lot of money, it’s possible to generate substantially more wealth over the course of your lifetime than someone that significantly out earns you assuming you have strong investing habits (and they don’t).
Let me give you an example. Let’s look at a hypothetical experienced compensation analyst job.
According to Payscale, the pay range for an experienced Compensation Analyst nationally is between $75,019 (at 10th percentile) and $105,930 (at 90th percentile).
Let’s assume for our purposes that there are two hypothetical 25 year old Compensation Analysts with similar experience, and that one makes $75k while the other is paid at the other end of the spectrum at $105k (we’ll ignore inflation, and assume neither promotes into a larger job over the course of their careers to keep this *super* simple).
The first Compensation Analyst, having earnings at the bottom of her pay2. Heh, pun. ^_^grade realizes that she must start saving early to compensate 2 for her relatively low earnings. The second Comp Analyst – flush with cash – doesn’t save anything her first six years in her new role, and only begins to save once she realizes she’s in her 30s and needs to start putting money away.
The below chart shows their outcomes assuming both contribute $10,000 a year into an investment account yielding an annual 8% compounding return on investment:
As you can see, the lower-paid Analyst has dramatically higher savings at retirement as a consequence of beginning to save early.
But this isn’t really realistic, is it? After all, the second Analyst earns nearly 30% more per year. She has the capacity to save more than her lower earning counterpart, right?
Let’s instead assume in our example that the Compensation Analyst making 105k saves 30% more money annually than the Analyst making 75k once she3. In keeping with the marginal propensity to consume, we won’t assume that she saves any more than this. As people earn more they tend to spend more (and there is nothing about this hypothetical analyst that suggests she is thriftier than her lower earning counterpart).finally begins saving: In keeping with the marginal propensity to consume, we won’t assume that she saves any more than this. As people earn more they tend to spend more (and there is nothing about this hypothetical analyst that suggests she is thriftier than her lower earning counterpart
Wow! Even saving 30% more than her counterpart annually through retirement, at 65 years old the higher earning Compensation Analyst is more than a half million dollars behind in savings. And take a look at the earnings from interest:
That six year, $60,000 initial head-start investment has turned into an additional $600,000+ in interest earnings for the 75k earner.
In fact, the Comp Analyst earning 105k would have to invest 63% more annually than the Comp Analyst earning 75k for the next 34 years to retire with the same amount of savings.
Of course, the big message here is to get to the top of your pay grade and save as much as you possibly can as early as you possibly can.
…But with that said, if it takes you a while to find the 90th+ percentile of earnings you will still be okay (provided you live like a Spartan and save all that you can).