After spending years as a loan officer I became quite comfortable with explaining the differences between two popular Individual Retirement Accounts (IRAs) - Traditional IRA and Roth IRA. Although my primary job was to originate credit cards, auto loans, and home equity lines of credit I always felt compelled to encourage my customers to begin saving sooner rather than later because I learned from a young age just how important it is to begin saving for retirement as soon as possible. When it comes to IRAs, there are three primary reasons why it's so important to save for retirement as soon as possible:

1. The amount that you can contribute on an annual basis is limited and makes every year that passes a wasted opportunity to invest.
2. The sooner you make a contribution the more time it has to begin compounding gains.
3. The more years you have to invest the better chance you will achieve a reasonable average return.

1. Limitations to Contributions

Let's assume that you plan to retire at the age of 65 and began working at the age of 22. This means that you have 43 years to amass the quantity of wealth that you will need to sustain your lifestyle going into retirement. Any year in which you do not make a contribution reduces the total number of years because there is no way to go back and contribute funds (unless it is prior to April 15 of the current year). For example, if I want to contribute money to my Roth IRA for 2018 I would still be able to do so until after April 15, 2019, has passed.

• Currently, the maximum you can contribute to an IRA is $5500/year although at age 50 that amount moves up to $6500/year. Therefore, under the first tier ($5500/year), an investor in this situation would be able to save a maximum of $154,000. Under the second tier ($6500), an investor would be a to save a maximum of $97,500. In total, an investor following this scenario would only be able to put away a maximum of $251,500 over the course of their working career.
• Every year that passes before the age of 50 means that you are forgoing 2.2% of the total amount you could've potentially invested.

At this pace, it would only take 4.5 years of missed contributions to have eliminated 10% of the total amount you can contribute during your lifetime. This becomes especially important for investors that do not have a 401(k) or alternative retirement source through their employer.

2. Time and Compounding Gains

There is no better way to demonstrate the importance of time and compounding them by providing realistic examples that drive the point home. In all of the following scenarios, we will use an average return of 7% annually.

• Baseline Scenario - An individual who is able to save the maximum amount in their IRA every year would ultimately have just under $1.5 million. In my opinion, this number is rather unimpressive because we have to consider the impact inflation will have had 43 years from now.
• Invest Early & Stop Scenario - If an investor only contributed $5500/year from the age of 22 to the age of 31 (10 years) and then never contributed another penny they would have over $750,000 by the time they reach retirement at age 65.
• The Final Scenario - Lastly, an investor that waits until the age of 32 to begin saving for retirement which means that they would only have 33 years to see if the necessary funds in order to retire at the age of 65. The individual and the scenario would only be able to contribute a maximum of $196,500 into their IRA over this time period. Using our average return of 7%, this individual would have an IRA net worth of approximately $727,000 by the time they reach age 65.

The lesson of the bullet points above is to show that the only way to generate a meaningful amount of wealth is by investing early on. In fact, if you consider the last two bullet points, you will actually generate almost the same total amount of wealth by investing $5500 from the age of 22 to 31 (a total of $55,000) as you would by waiting until the age of 32 and investing the maximum amount until age 65 (a total of $196,500). 

3. How Do You Achieve A Modest Average Return?

The more years you give your retirement funds to grow and reinvest the better chance you have to achieve a return that matches a modest average return. If we consider the long-term returns of the stock market, 6-7% as an inflation-adjusted rate of return would be considered normal. However, depending on the years when your money was invested in it was possible to achieve an inflation-adjusted return that was significantly better or significantly worse than the 6-7% target. Let's look at a few historical examples that put this in context.

• An investor who started saving 43 years ago (1975), would have seen an average return of 9.1% annually. Assuming our investor contributed the full $251,500 each year during this time frame it would have resulted in a net value of approximately $2.75 million. This compares to a net value of $1.48 million if the annual return was closer to 7% annually.
• An investor to begin saving in 1965 would have seen an average return of 5.93% annually assuming they had continued to save in their IRA over 43 years and ending in 2008. This would've resulted in IRA market value of just under $1.1 million.

It is important to remember that we must separate the things we control when it comes to investing and the things we should try and ignore because we literally will never have control of them. In the two bullet points above, we can appreciate that an investor has no control over how the market reacts during the time of their life when they are working and because of this we should not be concerned with timing. The only factors we do control in a scenario like this is how often we invest, what we invest in, and making changes to our gameplan (such as delaying retirement). The key is that an Investor who attempts to put their money to work too late in life is left to the mercy larger year-to-year swings of the market's average rate of return.

To support this claim I dug up some historical scenarios where we can compare the growth rate of the S&P 500 (dividends included). Look at the total average annual return for 1976-1985 (with the investment periods ending in December 2018).

• 1976 - 8.62% Average Return
• 1977 - 8.39% Average Return
• 1978 - 8.93% Average Return
• 1979 - 9.21% Average Return
• 1980 - 9.32% Average Return
• 1981 - 9.09% Average Return
• 1982 - 9.69% Average Return
• 1983 - 9.50% Average Return
• 1984 - 9.24% Average Return
• 1985 - 9.45% Average Return

From 1976-1985 the minimum average annual return was 8.39% and the highest was 9.69%, meaning a total range difference of 130 basis points.

Now, let's compare these average annual returns with a more recent group of years ranging from 1998-2007 (with the investment periods ending in December 2018).

• 1998 - 5.89% Average Return
• 1999 - 4.85% Average Return
• 2000 - 4.16% Average Return
• 2001 - 5.06% Average Return
• 2002 - 6.14% Average Return
• 2003 - 8.03% Average Return
• 2004 - 6.81% Average Return
• 2005 - 6.77% Average Return
• 2006 - 7.19% Average Return
• 2007 - 6.72% Average Return

From 1998-2007 the minimum average annual return was 4.16% and the highest was 8.03%, meaning a total range difference of 387 basis points (The range for 1998-2007 is 3x larger than the same range in 1976-1985). Therefore over a shorter time frame, the variance in returns for individual years is likely to be greater because it doesn't have as many years of history with which to arrive at a more stable mean. It's also important to remember that both of these timelines experienced major economic uncertainty so the argument that these timelines were cherry-picked is simply untrue. From 1976-1985 the US experienced major economic events including:

• In 1973 the US experienced the first oil crisis.
• In 1979 the US experienced a second oil crisis (Iranian Revolution).
• In 1982-1995 the US felt the impact of the savings-and-loan crisis.

From 1998-2007 the US experienced the following events:

• The US experienced major implications from the dot-com bubble from 1998-2000.
• The US invaded Iraq in 2003

The point is that more years of history will help to offset any outliers (both high and low) that can have major implications when it comes to the value of your retirement nest egg.

Conclusion

Whether investing in 2019 willing be your first time or you are the retiree who started investing 40+ years ago it is important to keep these three lessons in mind because they will help us all be more responsible investors. By focusing on the things control like investing regularly and budgeting we increase our odds of achieving modest average annual returns. It is also important that we ignore the things that we can't control since these types of situations only drain us of our energy and increase the likelihood that we will make poor decisions.