Here are Three Reasons People Don’t Invest Enough

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While discussing retirement with our students and clients, the most common obstacle we see for success is the concept of compounding. Since retirement investment returns are not linear, but rather exponential, it is difficult to stick to a plan that seems to take forever before you can even see a small amount of progress.

Lets take a look at a typical retirement plan for a recent 25-year-old college graduate that plans to retire at age 65 with an account worth $1 million. Of course if the goal is $2 million then simply double the amount of money invested each month and the math stays the same. To reach $1 million, assuming the student never increases her contributions, she will need to invest about $184 each month during her 40-year career. We are assuming she earns an average annual return of 9.5%, which should account for a solid S&P 500 Index fund with very low annual fees of well under 1%.

The Numbers

To reach $1,000,000 at age 65 she will have to invest $184 per month for 40 years. While $184 is not insignificant, it certainly seems possible, especially if she has a full time job after college. So why do people not stick with their investment? Well, notice on our chart that after 20 years of investing, which is halfway to age 65, she will only have about $131,000 invested. In fact, she will not reach $500,000 – which is half of her goal – until she is 33 years into her 40-year investment time horizon! It is only in the last 7 years, where the power of compounding really takes over and allows her to double that large amount into the $1,000,000 goal.

It is not difficult to see why someone would get frustrated. Now let’s look at this more immediately. Here is a recent graduate who likely has student loan payments every month ($250), a car payment ($300), and rent ($750). Add in a cell phone bill, Internet, food, and so on and sacrificing that $184 becomes a bit more difficult to stomach.

The Early Years

Now let’s look at her first few years of investing up close. After investing a total of $6,624 of her own money for three years, her account total is only $7,630. After all that sacrifice during her lowest three years of income (her entry level position) she has earned a measly $1,000 in interest. If investing was linear, which is how we usually think, that means in her mind she sees that she will invest about $850,000 of her own money for it to grow to $1,000,000 and that seems impossible… so she gives up. And this assumes she didn’t start investing right as the market had a downturn. She could actually see that her account has less in it than she invested if that was the case. It is no mystery why so many young people give up on investing.

So how can people overcome this linear thinking and start to see the exponential potential of compounding? Well, they don’t have to. Instead we need to stop focusing on the abstract value of $1,000,000 in 40 years. That seems neither attainable nor relevant.

Let's Focus On Small Goals Instead

Depending on the individual it may need broken down into individual years, but at the very least we can see where a person needs to be during each 5-year segment of their investing.

To reach $1 million at retirement, our student only needs to have $14,000 in her account in five years. She can focus on reaching $14,000 instead of focusing on $1,000,000 (Most people can wrap their heads around $14,000, even in their twenties.) Once she reaches the ripe old age of 30 and is on pace, her only focus is reaching $36,000 in the next five years. Each time she reaches the next level she feels a sense of accomplishment and sees her next goal as achievable.

Notice also, that instead of talking about years, the table lists her age. The table is more personalized to her situation with fewer abstract numbers that have little relevance and meaning. So why do very few people invest enough and stick with their program? Well, I am a big believer in personal responsibility, but with that said:

  • While educating others about personal finance we do not relate the numbers to the individual
  • Linear thinking in an exponential world makes the goal seem unattainable
  • Goals are not broken down into manageable steps

What Can We Do About It?

The great news is that by identifying the situation, we are better positioned to overcome the issues. Small numbers are easier to digest. During the first $14,000 goal, our student only had to invest $11,000 of her own money. But if she has a 50% matching contribution from her employer, she really only invested $7,360 of her own money… so about half. To reach the next milestone at age 35, she will have invested $22,000 – or less than $15,000 with the company match.

These smaller numbers help students and clients to better grasp what they need to do to achieve their goal. Of course this all assumes they first understand why they want to achieve that $1,000,000 in the first place. Without that foundational understanding none of this makes sense, so that conversation needs to take place first. After that is done you only need these three small steps to help your clients stick with the program and achieve their goal.

  • Illustrate the small steps that it takes to reach the goal
  • Emphasize the importance of consistency
  • Focus on the person and not the numbers. After all it is called personal finance for a reason.

If you would like to download a free copy of the Excel File used to create the tables and charts from this article, click here.

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Bill Pratt

Bill is an Assistant Professor of Business at Piedmont Virginia Community College. He speaks on topics related to personal finance on college campuses across the country and is the author of multiple books on personal finance. He left the financial industry to focus on helping people become personally and financially successful. He lives in Charlottesville, VA with his wife and their three pets.

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