The benefits of starting your pension funding as early as possible are immense. Now, we are not suggesting that everyone should live a life of penury in their 20s and 30s in order to safeguard their lifestyle in their later years. But starting a pension plan early has a significant impact on your final retirement outcome, and this is down to one main factor: the effect of compound interest.

The Rule of 72

To look at compound interest, it is useful to consider a maths equation commonly known as “The Rule of 72”. This is a simplified way to determine how long an investment will take to double, given a fixed annual rate of interest. All you have to do is divide 72 by the expected rate of return. The answer is the number of years it will take for the amount of money to double. Consider two examples of how you can use this below:

• If you are aiming for a return of 6% p.a., it will take 12 years for your investment to double (72/6% = 12 years).
• If you want to double your money in 10 years, you will need to achieve a return of 7.2% p.a. (72/10 years = 7.2%).

The impact on your pension plan

This rule demonstrates that a contribution made to a pension plan in your 20s or 30s has the benefit of time on its side to grow very significantly from the time it is made to your retirement age. And because you have this time on your side, you will probably also be willing to take some risk with your funds, aiming for higher growth rates.

These higher growth rates may be achieved through investing in the likes of equity (stock market) funds. If you had invested in the S&P 500 Index of shares from 1st January 1985 to 31st December 2023, your investment would have achieved a Compound Annual Growth Rate (annualised return) of 11.40% per annum over the 30-year period! Now, of course, previous returns are not necessarily a guide to future performance, but they give a sense of what can be achieved over a long timeframe.

So, when you put higher potential growth rates and a longer term together, the impact can be significant. Instead, if you wait until much later in life to start your pension planning, you will want to be more cautious in your investment choices (to limit any downside risk), thus reducing your potential growth rate. You also won’t have the investment duration to benefit from the compound interest effect.

So yes, live your life for today while you’re young. But doing this with some investment in your future will yield great benefits when you do eventually hang up your working boots!