In a previous post, we discovered a hopeful truth: an average American household could become a millionaire simply by consistently saving 10% of their income and investing it all in US stocks.
Now, let’s dig deeper into that message, specifically focusing on when to save. The interplay of saving and investing has been a common theme in my recent posts (this, that and the other). This is the last post on the topic. After this, I will start writing about investing.
The Power of Consistent Saving: A Baseline
The chart below shows the income of the median household in the United States since 1984.
We assume that our chosen household earns the median income every year from 1984 to 2023, a typical 40-year working period (ages 25 to 65). If this household saves 10% of its income annually and invests it entirely in the S&P 500 index of American stocks, how much wealth would they accumulate by the end? Starting from nothing in 1983, this median-income household would amass over $1.4 million by 2023. The figure below shows how this household’s net worth grows over time. The net worth in every tenth year (1993, 2003, 2013, 2023) is shown on the chart.
When You Save Matters: Early Bird vs. Late Bloomer
The $1.4 million figure from the consistent 10% saving scenario is compelling. But what if that average household saved the same 10% overall, but not regularly each year? Let’s consider two alternative saving strategies:
- Option 1: Early Saving: The household saves double (20%) of its income each year for the first 20 years, then saves nothing for the last 20 years.
- Option 2: Late Saving: The household saves nothing for the first 20 years, then saves double (20%) for the last 20 years.
In both options, the average savings rate over the 40-year period remains 10%. We also assume that in all scenarios, the household remains invested in US stocks the entire time, and any accumulated savings are not spent.
The figure below illustrates how this household’s net worth grows under these three different saving timelines. Early savings lead to a higher net worth of just under $2.3 million. Steady 10% savings lead to the net worth of $1.4 million, as we saw before. Late savings lead to a much lower net worth of $0.62 million.
The Unmistakable Power of Compounding
The takeaway is undeniable: saving early is profoundly better. What makes this even more remarkable is that the early savers contributed fewer total dollars – just over $0.13 million in their first 20 years. This is because median household income was lower in those earlier years. In contrast, the late savers contributed a much larger $0.23 million in total. And yet, the early savers, who saved nothing during the last 20 years, ended up with nearly 4x more wealth than the late savers! As you might have guessed, the early savers won because their savings had significantly more time to compound.
On a personal note, I did not start saving early. I did not earn much in engineering graduate school. I was frugal but I had dependents, which left me with hardly any savings. After I found an industry job, I saved much but initially invested poorly. If I had invested in a low-cost stock index fund, I would be better off. Frugality saved me. As the years passed, my knowledge grew, and I made fewer investing mistakes. Now, I share insights backed by data and analysis with others.
My experience is not unique. Our lives don’t unfold like steady lines on a graph. I know no one whose journey of wealth has been perfect. But there is also plenty of hope. Many of us end up with enough wealth despite occasional blunders.
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