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Graduation season always brings an equal mix of hope and anxiety about the future: Hope for what young, bright minds unleashed into the world might do, and anxiety that they will find a decent job. One part of the future that is rarely part of any graduation party chatter, however, is retirement. And that’s a shame. Because young adults in their early 20s are in a unique and quite temporary situation to set up a comfortable, long-term future.  In fact, thanks to the “miracle” of compounding interest, here’s an oddity you probably won’t believe until I prove it:

Someone who saves for retirement from age 20 to 30 and stops has more money at retirement — MUCH more – than someone who saves from age 30 to 65.

The relationship between money and time is a funny thing, and it’s often hard to get our heads around. This one is so hard to believe on its face I’m going to restate it: a college grad who saves through her 20s, and stops at 30, is better off at retirement than someone who starts saving at 30 and puts aside funds for the next 30 years or so. That means when you are giving graduation gifts this season, consider doing the nerdy thing: instead of giving your niece or nephew a check they will blow on a vacation with friends, make a deposit into an IRA for them instead.

Parable of the Two Twins

OK, here’s what’s going on. Financial advisors sometimes call this phenomenon the Parable of the Two Twins. Liz Pulliam Weston, in her book “Deal with Your Debt,” offers this version of the story. One twin puts aside $3,000 every year in a Roth IRA starting at age 22, and stops at 32. She never adds another penny. Her brother starts saving $3,000 annually at 32, and continues until age 62.

Assuming an average 8% return annually, the twin sister wins easily. When both turn 62, she has $437,320, compared to her brother’s $339,850, even though she contributed far less of her own money than her brother ($30,000 vs. $90,000).

Somewhere in the back of your mind, you’ve seen a chart that shows the incredible value of compounding interest over time — or the pain of compounding fees or mortgage interest over time. This is why most people spend more than double the price of their home on their mortgage, for example.  The longer the time horizon, the more severe the impact of compounding interest. Perhaps you’ve heard about the rule of 72, which gives you quick math to learn how long it will take for an investment to double. Let me simplify that for you and rough out that, earning 10% annually, your money will double about every seven years.  Let’s look at how important the value of an extra round of doubling can be later in life:

  • 23: $10,000
  • 30: $20,000
  • 37: $40,000
  • 44: $80.000
  • 51: $160,000
  • 58: $320,000
  • 65: $640,000

This simple chart shows you at a glance how punishing the Parable of the Two Twins can be to the foolish brother. Add seven extra years at the end of a retirement strategy, and you add one more round of doubling — in this rough example, you add $320,000. Even someone who starts later and tries to pile on the cash to catch up has a tough time making up for that lost, last doubling of the money.

The Catch in This Strategy

It’s very hard to get a 23-year-old interested in saving for retirement, of course. Data bears this out. A study by Aon Hewitt in 2010 found that workers under age 30 average 5.3% contributions to their 401(k) plans, as compared to 6.8% by workers 31-45 and 8.4% by older workers.

Most people encounter the Parable of the Two Twins when they are older, and it fills them with pangs of regret. Here’s the bad news about the story. Naturally, saving money for retirement at any time is a good idea. Hearing this math might inspire you to redouble your savings efforts. It doesn’t matter. There is no fountain of youth, and there is no way to make up for time lost NOT saving for retirement in your 20s.

So, as you pick out a graduation card and think about what you plan to give to the young, hopeful, anxious graduate in your life this season — do what you can to help her be the wise twin.  You might not be the most popular uncle at the party, but you’ll probably have a nice guest room to visit in your old age.

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