Think about how much money you spend now (all your fixed expenses plus the amount of spending money you need) and how much money will you need to save up in order to cover all those expenses in retirement.  The sooner you save that money, the sooner you can retire and go play golf everyday.

Lets say in retirement you will need $50,000 a year (in today’s dollars – no inflation).  Once you are retired, you would not want to risk losing your retirement savings (you would have to return to the work force to earn it back) so lets say you put your retirement nest egg in something super safe that pays 5% a year like treasury bonds.  At 5% rate of return (assumed to be the risk free rate) you would need to save 1 million dollars to get $50,000 each year without eating in to your principal.

*This is a simple example – in reality you would want to diversify your retirement nest egg and have a portion of your retirement portfolio take on short term risk in order to compete with inflation until your estimated age of death.  You would also want to eat into a portion of your retirement principal so that is zero’s out beyond your scheduled life span.

For those of you not approaching retirement the task of saving such a huge amount of money is a lot easier than it sounds.  As Mick Jagger says: time is on your side.  You get to take advantage of the power of compounding returns on you money.

You are also less risk averse (in theory if you lose all your retirement savings, its ok because you are still young and can still make a living and begin saving up again.)  Due to inflation (and taxes depending on where you are investing) it is actually riskier to save your money in conservative instruments over the long term.  For example:

Rate of return on savings if invested in bonds (30 yr. Treasury)__________  6%
Less taxes_________________________________________________( 2%)
Reinvestment hassle (finding same rate of return on the coupon)_________(.5%)
Less historical rate of inflation (3-4%)____________________________( 3%)

Total rate of return___________________________________________  .5%

If your tax rate is 40%, you would actually be losing money each year you hold these bonds.  If inflation increases above 3% (you know it will) you will be losing as well.  This method is however better than hiding cash under your mattress and Treasury Bonds are safe and guaranteed.  The risk involved here is keeping up with inflation.

Although equities and other investments are deemed more risky (because of their volatility) their historic rate of return makes them a mandatory investment vehicle when your time horizon allows you to wait out the fluctuations.

For those of you with retirement approaching, it is more difficult to save, the risk factor limits your options on they type of investment vehicles you should be using.  You also will not have as much of a benefit from compounding returns.  You are forced to save as much as you can ASAP.

Moral of the story – it is never too early to begin saving for retirement.