A column in last weekend’s Globe and Mail implores readers to stop procrastinating and start saving money as soon as possible. A typical example is provided to show the power of compounding: Mr. Early invests $5,000 every year for 10 years and ends up with a larger nest egg compared to Mr. Late who started investing just 7 years later and continues to invest the same amount for 28 years.
While the example is very powerful, there is a bit of fallacy involved because the effects of inflation are completely ignored. In the example quoted in the article, Mr. Early invests a total of $50,000 and ends up with a nest egg of $496,055. Mr. Late, on the other hand, invests a total of $140,000 and his nest egg only grows to $476,695. If we assume that inflation runs at a modest 3% rate, Mr. Early’s inflation-adjusted investment is $120,000 and Mr. Late’s real investment is $226,000. Note that Mr. Late’s total investment is double that of Mr. Early’s, not triple as in the original example.
Investing early pays a rich dividend as evidenced by Mr. Early’s bigger nest egg despite investing only half of what Mr. Late did. It is just that the advantage, while still huge, is not as large as it is usually advertised.