8 Benefits of Saving Money for Retirement While Your Young
The best time to start saving for retirement is right now.
English
Why should you care about the benefits of saving money for retirement if you are just in your 20s or 30s and retirement is still a few decades to come?
Well, different studies reported by Al Arabiya have shown that about 45% of residents and 50% of expatriates in the UAE and the wider Gulf region do not have any retirement plan despite the fact that they pay little or no income tax.
Two things make this statistic even more worrisome.
First, many people want to retire as early as possible, according to David Kneeshaw, group chief executive at Friends Provident International, an insurance company.
Second, life expectancies in the Middle East are increasing (which may be the result of improved healthcare), according to Rickson Dsouza, a consultant at The Continental Group, a global holding company.
These two facts mean that the number of years people have to live in retirement is higher. Consequently, they need to start saving money for retirement as early as possible to be able to retire when they want and sustain themselves throughout retirement years.
In this article, we will identify and explore 8 benefits that come with saving money for retirement while you are still young.
[Do you want to save more money towards your financial goals? Download the MALY app to automatically round-up small amounts of savings from your daily purchases.]
Compounding is the eighth wonder of the world, according to Albert Einstein.
In the world of financial planning, the effect of compounding can be seen in what is called compound interest especially in contrast to simple interest.
A 10% simple interest on AED 1,000 will leave you with AED 100 in the first year. In the second year, you will earn another AED 100, bringing the total amount to AED 1,200.
In contrast, for compound interest, every bit of interest earned also earns additional interest. So, in year 2, both the original AED 1,000 and the AED 100 earned in year 1 will also earn interest. Consequently, the total amount will be AED 1,210 (AED 1,000 + AED 100 + AED 100 + AED 10).
A AED 10 difference might seem insignificant but, as the chart below shows, the longer the years, the larger the difference between simple and compound interest.
How does this apply to retirement planning?
Well, it shows that the longer the time your money spends in the financial market, the more compound interest it can generate.
Let’s consider two people – Mr. A and Mr.B. Mr. A started investing AED 5,000 at the end of every month in 2021 when they were both 25 while Mr. B waited until 2 years after to start doing the same thing. Assuming a 10% rate of return and quarterly compounding of interest, let’s consider how they have fared by 2031.
By then, Mr. A’s retirement savings would be AED 1,019,463.62, of which AED 419,463.62 is the accumulated interest and AED 600,000 is the total invested capital.
In contrast, Mr. B’s retirement savings would be AED 728,272.95 of which AED 248,272.95 is the interest earned and AED 480,000 is the total invested capital.
Note that Mr. A has AED 291,190.37 more than Mr. B even though he had only contributed AED 120,000 more than him. The remaining AED 171,190.37 are purely the results of compound interest not extra contribution.
(All calculations were done on The Calculator Site)
In essence, by starting just two years earlier, Mr. A was able to gain extra AED 171,190.37 in accumulated interest. Now consider what that amount can do for Mr. A in retirement.
To summarise, because of compound interest, the answer to the question, “when should you start saving for retirement” is “as soon as possible.” As every financial advisor knows, the earlier you start, the more compound interest you can gain.
This leads us to the second of the benefits of saving money for retirement while you are still young: you can do more with less.
Let’s go back to our example.
Note that for Mr. B to have the same nest egg (retirement funds) as Mr. A, he would have to be saving approximately AED 7,000 instead of AED 5,000 at the end of every month.
The point here is simple: by starting early, you can get the same nest egg as someone who started late while contributing lower amounts.
By our calculations, Mr. A has an extra AED 2,000 (compared to Mr. B) that he could use for whatever reasons he so desires. Yet, he will still have approximately the same result as Mr. B. And this is because he started two years earlier. With any amount above AED 5,000 he already has more than Mr. B even though he is saving less.
Now imagine that Mr. A started in 2019 instead (two years earlier). This means he would have invested in the market for 12 years instead of 10. In this new scenario, he would only need to save AED 3,710 monthly to get approximately the same results as Mr. B saving AED 7,000 every month for 8 years. If he saves AED 3,750 (just AED 40 more), he will have AED 10,000 more than Mr. B at the end of 2031.
We call this doing more with less.
One of the truisms in the world of personal finance is that the longer the time you spend in the market, the less the risk of losing money and the higher the probability of making money.
Data collected between 1926 and 2017 by the Center for Research in Security Prices has supported this. The chart below, produced by Bourbon Financial Management, a financial advisory firm, shows how the times an investor lost money reduces as the time spent in the market rises.
Source: Bourbon Financial Management
The reasoning behind this truism is that over the long term the stock market often has more good days than bad days. Therefore, those who are able to stay for the long term can benefit more than those who only stay for the short term (whereas for any short period, the bad days may exceed the good days).
This is one of the reasons why Warren Buffett said that if you are not ready to own a stock for 10 years then you should not even think about owning it for 10 minutes.
Who is more likely to be able to save AED 5,000 every month from a AED 50,000 income : A 25-year old single person or a 35-year old married person?
All other factors held constant, it seems that for some people it could be easier for the 25-year old single person.
The simple point is that retirement savings may be easier to accumulate before marriage and child rearing responsibilities arise. Even though income might increase as one gets older, it is often the experience of many that the responsibilities find a way to keep up with the higher income.
Given the advantages of compound interest, the higher amount you are able to contribute before marriage and child-rearing commitments will provide you with a much larger nest egg by the time retirement sets in.
“The most important quality for an investor is temperament, not intellect,” said Warren Buffett.
Most people lose money because they get emotional when investing. According to Buffett, the two main emotions in this regard are fear and greed.
Greed makes people invest in a popular stock because everyone is doing the same. However, because the stock is already overvalued (due to the prevailing excitement), the emotion-laden investor ends up paying more than necessary.
By the time the excitement cools and the stock begins to lose value, fear sets in and the investor sells, afraid to lose more. In the end, he has bought high and sold low. “The average man … tends to buy high and sell low,” said Ray Dalio, an American investor.
Source: A Wealth of Common Sense
The only way to overcome this fear and greed cycle is to run away from emotional investing.
Those who embrace a long-term approach to investing are less likely to be in the throes of emotional investing.
By starting your retirement planning early, you have enough time to stay in the market and reap the fruits of long-term investing, thus making it less likely that you will be mastered by the fear and greed cycle.
On the other hand, if you wait too late, you might be tempted to choose a risky or get-rich-quick scheme in a bid to make up for lost years and attain the nest egg you desire.
“As one gets older, without a retirement plan in place, investing runs into complexities,” said Dsouza. “the lack of time to accrue a certain wealth encourages people to consider riskier propositions, at times leading to setbacks.”
We saw in the introduction that people now desire to retire early and that people also tend to live longer now. In essence, people now have less years to prepare for a longer retirement.
Yet everyone wants to live well in retirement; they want to have enough money to purchase sufficient health insurance (and probably life insurance), travel the world, among other things.
The only way you can guarantee such good life in retirement is to start saving money early. (The only alternative is starting late but saving a significant portion of your income, which is more difficult).
It is only by starting early that you can avoid working during your retirement years (against your desire) to supplement your retirement income (distributions or withdrawals from your retirement account[s]). This is also the way to avoid living significantly below your desired income level during retirement.
Relatedly, by starting early, you can even be in the position to retire earlier than expected.
Your calculations might suggest that you will be ready to retire by 60 (the retirement age in the UAE) while your retirement portfolio might perform so well that you are ready to retire before that.
If you don’t start early, you won’t have this luxury.
A whole movement even developed around the concept of retiring early. It’s called “Financial Indepedence, Retire Early (FIRE).”
By starting early and by saving a higher portion of their monthly income than others, people in this movement have been able to retire as early as 40.
Youth (including young adulthood) is often the time of high-octane energy. Without the necessary discipline, it is possible to misuse this period and regret it later on.
On the contrary, by embracing the financial discipline needed to start saving for retirement at this period, it becomes easier to build discipline in other areas of life. As John D. Rockefeller, one of the richest men in modern history, puts it, “thrift is essential to well-ordered living” or in the words of T.T Munger, late American theologian, “the habit of savings is itself an education.”
More specifically, by building the discipline to save for retirement, you can also save for other purposes: down payment on a mortgage, starting a business, educating your child abroad, etc.
There is no compulsory national pension scheme in the UAE that is comparable to the Social Security Administration in the US.
Individuals looking for retirement accounts can choose to enrol in any employer-sponsored pension plans or an individual retirement account offered by investment management companies. Those who think their employer-sponsored plan is insufficient can also enrol for an IRA.
So far, we have seen that “today” is the right answer to the question, “When should you start saving for retirement? “
But given how hard it is for many people to save in Dubai, this answer might sound easier said than done.
Even a list of tips for saving money is not always enough.
What can then be done to help UAE residents save more, whether for retirement or other purposes?
Maly has answered this question by proposing two solutions.
First, in adherence to Buffett’s principle of saving before spending, Maly has provided a feature that will allow you to automate your savings. That is, if you find it difficult spending according to your budget, you can overcome it by automatically saving a portion of your income once it arrives and then “forcing” yourself to live within what remains.
You can set a daily or weekly or monthly savings plan (making it open to employees and self-employed people). Once you have set this plan, Maly will automatically deduct the stated amount at the stated frequency.
The second solution is saving money while making purchases. Have you been in a situation where you had to pay AED 190 for a product in a supermarket? What if you could just pay AED 200 with the remaining AED 10 automatically added to your savings account?
This is what Maly has provided for UAE residents. You can now round up your purchases to the nearest 1, 5, or 10 dirhams with the extra money saved to your Maly account.
In this way, spending and saving can co-exist: as you are spending, you are also saving.
While Maly does not provide an individual retirement account (IRA), you can use it to save for other purposes – emergency fund (an alternative to dependence on credit cards) and other short-term financial goals (like downpayment for a mortgage, car purchase, etc.).
However, you can also save money for retirement there until you are sure of the retirement account you want to choose. And if your retirement account providers have a minimum investment requirement, you can accumulate your savings in Maly until you are ready to open the retirement account.
[Are you finding it hard to save money in Dubai? Download the Maly app to automatically save money from your income and purchases so you can more easily achieve your financial goals.]
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