It pays to start saving early and for a longer period

From my previous article, it was noted that most Kenyans are not saving enough for retirement. In fact, we found out that on average a member of a retirement benefit scheme will only be able to replace 34 per cent of their salary before retirement.

This Income Replacement Ratio is way below the recommended range of between 60 and 80 per cent. As a closing remark to the article, I had mentioned that the Income Replacement Ratio is affected by the amount of time a member saves for, among other factors.

Note that when I say “save” I mean the monies should be saved in a retirement benefits scheme run by your employer or saved in an individual pension plan registered at the Retirement Benefits Authority(RBA) and not stashed under the bed or the pillow.

In this article, I will take you through the importance of starting to save early and for a longer period of duration.

First off, when it comes to saving for retirement, it’s never too early to start. In fact by starting early and staying invested, you can reap the advantages of compound interest.

Warren Buffett, among the richest in the world, said “My wealth has come from a combination of living in America, some lucky genes, and compound interest.” Since we don’t live in America and most of us don’t have lucky genes, we have to rely on compound interest, which should be every investor’s best friend.

The concept behind compound interest is when the money earned from interest on your savings or investments is reinvested which earns further interest. In simple terms, it is “Interest on Interest” or “Making money on your money”.

The compounding effect on your savings is much better and more fruitful when the monies are invested or saved for a longer period. Above is a graph that demonstrates the impact of NOT starting to save early or saving for a longer period of duration for someone who saves Sh20,000 per month up to age 60:

From the graph above, a 20-year-old who starts working and earning a salary decides to start saving, he will have a retirement pot of approx. Sh50 million at the age of 60. Out of the Sh50 million, 19 per cent is his savings and 81 per cent is the interest earned on the savings.

If he delayed saving and started when he is 30 years of age, he would have lost 53 per cent of the Sh50 million. This loss is because of not having saved for 10 years and the loss on the interest from saving.

If he delays for a further 10 years and starts saving at age 40, then he loses out 79 per cent of the Sh50m. Therefore, waiting to start saving can cost you a lot of money and have a major impact on your retirement pot.

Did you know, in Kenya, the legal age to start working is 18 years old? This means one can start earning a salary or open up their own biashara and start saving into their employer’s retirement benefit account or into a registered individual pension plan from age 18.

So what do you think is better: starting early and keeping your money invested up to age 60 or starting when you are 40 and accessing your retirement benefit at age 60?

Arth Shah, Actuarial Analyst at Zamara Actuaries, Administrators and Consultants Limited.