You have probably heard over and over that one of the best ways to begin a disciplined savings program is to pay yourself first. If you haven't yet been convinced of the wisdom of this strategy, consider two friends, the Turtle and the Hare, who take different approaches to saving.
Turtle, who believes in paying himself first, deposits $100 each month for 10 straight years into an account earning interest compounded monthly. After 10 years, Turtle stops making deposits and simply leaves the account to grow.
During these ten years, Turtle’s good friend Hare intends to save what's "left over," but finds that he spends everything and there is nothing left over to save. Finally, in the eleventh year, Hare decides that it's "better late than never," and begins making monthly deposits of $100 into a similar account. Hare continues making deposits for the next 40 years.
The chart below shows the savings growth under two rates of return, 6 and 8 percent, compounded monthly. Let's take a closer look to see who crosses the finish line first.
Illustration is hypothetical and not indicative of any particular investment.
At a 6 percent rate of return, Hare ($100,452) finally edges ahead of Turtle ($98,698) in year 40. However, in those 40 years, Turtle’s total investment is only $12,000 ($100 per month for the first 10 years), while Hare's total investment is $36,000 (nothing for ten years, $100 per month for the next 30 years).
However, with deposits earning an additional 2 percent, something dramatic happens: that is, at an 8 percent rate of return, Hare is still chasing Turtle after 50 years, despite the astonishing fact that Hare's total deposits ($48,000) are now four times as much as Turtle's ($12,000)!
Even more startling is the fact that at 8 percent, the gap between Hare and Turtle widens every year. At 8 percent, Hare can go on depositing $100 per month for the rest of his life, and will never catch up to Turtle!
The lesson is clear: If you want to be the first to cross the finish line, pay yourself first! Let time and the "magic" of compound interest go to work for you!
"A Savings Fable-The Turtle and the Hare." FMex. 2015.
