The average age of retirement is 62. That means most people spend two-thirds of their lives working and one-third retired. At the end of their careers, many people look back and wish they had more time to pursue other passions or start a business, but there’s no better time than the present.
Here are five if you’re in your 20s and looking for reasons to strive for financial independence as soon as possible.
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Reason 1: Compounding
Compounding may seem like a foreign concept if you’re a young person. But it’s a powerful financial literacy tool that can help you become financially independent in your 20s.
Compounding is the process of earning interest on your interest. For example, if you invest $100 into an S&P 500 index fund that yields 5% per year, at the end of the first year, your investment will be worth $105—that is, $100 invested plus 5% in interest earned over one year. The next year (assuming an annualized return of 5%), your money will grow to $110 or another 5% on top of what was previously invested; this trend continues each time you earn additional interest until eventually reaching some vast number (theoretically unlimited).
The great thing about compounding is that it allows wealth to build upon itself: only by reinvesting those earnings can we continue growing our capital. This means that if we can find ways to increase our earnings by working more hours at our job or starting our own business (or both), we won’t have any trouble hitting financial independence early in life.
Reason 2: The Power of Time
The second reason you should pursue FI as early as possible is that, in the long run, time is your most precious resource. “Time is your greatest asset and the most powerful thing you can leverage to maximize your wealth. The more time you have, the more money you can make, and the faster your investments compound,” says Retire TruNorth, a leading financial advisor in Greenville SC.
The power of compounding means you have less money to save every year. If you are young and just starting a career, it’s unlikely that your income will grow at a rate higher than inflation (3-4% annually). If so, saving $100 per month for 40 years at a 4% return rate would give you over $1 million.
However, if instead of saving $100 per month from age 25-65 (the equivalent of working full time until 65), you wait until age 35 to start saving for retirement without any additional increase in income or savings rate along the way (say 5%), then by age 65 when it comes time to retire on your nest egg, it would be worth only about $630k. That’s a pretty extreme example, but it illustrates how powerful compounding can be when starting early compared with later life.
Reason 3: Diversification
Diversification is the process of ensuring that your investments are not concentrated in a single asset class. Diversification can be achieved by investing in various assets, different asset classes, and even different countries.
A portfolio’s risk-adjusted returns will be maximized through diversification. This means that you should have a broad base of investments to capture all available growth opportunities and minimize your overall investment risk.
Diversifying your portfolio involves having different types of investments, such as stocks, bonds, and cash equivalents which each have their unique characteristics (i.e., risk/return profile)
Reason 4: You Have the Most Time to Experiment
Another reason you should pursue FI in your 20s is because you have the most time to learn from your mistakes. If you decide to start investing while working, you quickly lose sight of your goals and get distracted by other things like relationships, partying, and other non-essential activities.
You can also take advantage of this time by starting small and slowly increasing your investments over time. As long as you stay focused on what matters (achieving financial independence), each year will bring more capital for investment until you eventually reach FI.
Reason 5: There’s no Better Time than Now
In your 20s, you have more time to learn about investing, build a nest egg, and save money. You also have more time to make mistakes and learn from them—which means a greater chance of success when achieving FI.
And if you decide you want to work for yourself in the future (instead of for someone else), starting early gives you more time for experimentation with different business ideas before taking the plunge into self-employment full-time.
Conclusion
The next decade of your life is the one that will most profoundly impact the rest of your life. By investing in yourself now, you’ll have the opportunity to enjoy greater freedom and flexibility when you’re older.
