I’ve often lamented about getting a late start in the savings game. Unlike many of my peers that went into the workforce at 22 years old, I opted to head off to law school (and goofed off for a year before doing that). Choosing this path meant that I had to take out nearly six figures worth of student loans and made it so that I earned essentially no income for the majority of my twenties. By the time I started my first job, many of my friends had already been in the workforce for 4 or 5 years.
When it comes to late starts though, I don’t think anyone can beat my wife. She spent five years in college, another four years in dental school, did a one-year general practice hospital residency and is now currently in year two of a three-year specialty residency. For those of you keeping track at home, that’s 8 years of post-college training! And unlike medical residencies, most dental residencies pay nothing or offer their residents a tiny stipend (usually a few thousand bucks a year – my wife made about $4,000 total in 2016). By the time Mrs. FP earns her first real paycheck, she’ll be 32 years old. Oh, and she’s also got a healthy six figures of student loan debt to boot. Quite a position to be in at 32 years old.
Going a decade without an income isn’t great for anyone financially and it’s especially worse when you come out of it with a ton of debt. It’s why any medical professional or lawyer needs to be super aggressive with their savings and debt crushing plans. When you’re starting off your working career so late, saving 10 or 20 percent per year just isn’t going to cut it.
The good thing though is that if you opted for a professional degree, you’re hopefully going to be in a position where you can earn much more than an average income. You need to treat that income wisely. How you use it right off the bat and the way you think about that income is going to matter a ton.
So for us late starters out there, the options are pretty simple. We can give up and blow all of our money. Or we can roll up our sleeves and play some catch up.
The lucky thing is that given how compound interest works, playing catch up is pretty easy.
The Doubling Penny Example
My favorite way to demonstrate the power of compound interest is through the example of the doubling penny. Basically, this hypothetical asks you a question – would you rather have a million dollars right now or a penny doubled every day for 30 days?
Without much thinking, most people would opt to take the million dollars upfront. A penny is such a tiny amount that it doesn’t seem possible for it to turn into more than a million dollars, even if doubled every day.
Of course, a question that simple must have a trick answer, and indeed it does. Just take a look at the doubling penny in action:
Turns out that the penny doubled every day for 30 days becomes well more than a million dollars. By day 28, your penny has already become more than a million dollars. By day 30, your penny has turned into $5,368,709.12. It really goes to show you just how valuable compound interest is.
So what does this mean for someone like me who is getting a late start in the savings game?
Compound Interest Doesn’t Matter Early On
The power of compound interest is an amazing thing. It can turn pretty regular sums of money into enormous sums of money. It’s how that penny can go from a single penny to over 5 million dollars.
The good thing for us late starters, though, is that compound interest doesn’t actually do all that much in the beginning It’s hard to think about it, but money doesn’t grow in a linear fashion. Instead, it’s exponential. If you let your money grow over a decent period of time, it’ll probably look like the graph below:
You can see that at the front at the beginning of the line, growth is slow. The amounts are just too small for compound interest to do a whole lot. Sure, your money is still growing, but not at huge clips like it’ll do later on in life. The exponential power of compound interest just hasn’t had the time to take hold yet.
This is good for us late starters though. It means that it’s possible for us to save aggressively and get ourselves right back into the same position as our peers that have been able to save for much longer.
It’s Easy To Catch Up
Let’s go back to the doubling penny. You can see that in those last few days, the penny is just too far ahead for most people. Anyone getting started at that point will have a hard time catching up to that penny.
But if you’re a late starter, it means you’ve got an incredible opportunity to get yourself right back on track early on. Five days in and the penny is worth just a few cents. By day ten, that penny is still worth only five bucks. That means playing catch up isn’t all that hard. If by day ten, you find yourself wanting to get in on that doubling penny action, all you need to do is save up five bucks as fast as you can.
That’s how my wife and I look at our savings plan – it’s a game of catch up. Sure, we’re starting out our savings journey late. I didn’t start aggressively saving until 2016. My wife hasn’t really been able to save anything since she’s never earned a real income. But the nice thing is, we’re only five to ten years behind most of our peers. Even someone who has maxed out their 401k since graduating college (which I think isn’t very likely for most people), would have put away about $180,000 over the last ten years. That’s a huge number, sure, but it’s not an insurmountable amount. All we have to do is put away $60,000 per year for 3 years to end up right at the same level as someone who’s been saving fairly aggressively for a decade. Save $100,000 per year and we’re potentially ahead of the person that’s been saving a good amount for their entire 20s. Considering that we should be earning well into six figures as a lawyer and dentist couple, that type of saving isn’t an impossible thing to do. And it’s not necessarily impossible for other folks either that are coming from similar backgrounds.
What You Need To Do
- Don’t succumb to lifestyle inflation. Without a doubt, falling into lifestyle inflation will destroy you. You see medical folks and big shot lawyers do this all the time. Instead of living like a student early on, new grads snag that first paycheck and then go to town with it. Some buy a huge house. Others get the luxury apartment or the nice cars. You cannot do this if you want to catch up to your peers financially. It’s much easier to keep the status quo then it is to downgrade your life. If you upgrade your life right away, you’re going to have a hard time cutting back in the future.
- Stay humble. Remember, even if you’re a big shot lawyer or doctor, you’re starting off way behind everyone else. Your friends have had years to build their careers and save money. You just got your first paycheck. Keep that perspective in mind. I think if you stay humble, it makes it much easier to avoid the problems of lifestyle inflation and to be happy with what you already have.
- Invest aggressively. No doubt about – you need to play catch up. And the only way to do that is to save as much money as you possibly can. This can include paying off debt aggressively as well. Remember that saving 10% or 15% of your income isn’t going to cut it when you just got your first paycheck in your late 20s and early 30s. If you’re trying to catch up, you need to be saving more like 30% or 40% of your income. If you can swing it, saving 50% or more of your income is ideal.
I’m still bummed that my wife and I are starting our savings journey so late. But the more I think about it, the more it doesn’t seem so bad. My wife and I are only 30 years old right now. The mighty power of compound interest probably hasn’t taken hold yet for most of our peers. It means that even though we’re behind, we should be able to catch up pretty quickly.