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Why saving and investing in your 20s is so important

The 20s is the time to work and work hard. You will never have a decade with as much freedom as you do then. It’s the time to generate memories, friends from around the globe, skills to set you up for your future and a money base..

That doesn’t mean excluding all social activities and living a frugal life like a monk either. It’s about creating a platform to stand you in good stead for the rest of your life. That means more than money of course. It’s about a network of friends, a solid educational base and the beginnings of your financial base.

Making work your core rather than spending each and every paycheck on treats for yourself will mean that money will take care of itself and you won’t need to drastically cut back your lifestyle in later years to save a few hundred dollars a year.

If you enter your 30s with not much to show from that decade, you are likely to end up wishing you’d made more of your 20s, and those regrets can pull you down even further. Your 30s are usually when kids and a mortgage happen and as many parents and homeowners can attest, that’s not cheap.

Cost of kids and mortgages

In 2013, AMP and the University of Canberra estimated it would cost $812,000 to raise two kids in Australia for the typical middle-income family, $474,000 for lower-income families and a whopping $1,097,000 for higher income families.

Cost of children

Source: National Centre for Social and Economic Modelling, University of Canberra

A mortgage of $500,000 – which wouldn’t buy much in capital cities like Sydney and Melbourne -could end up with a total cost of more $966,000 at an interest rate of 5% over 30 years.

In other words, a family with two kids and a smallish mortgage could fork out close to $1.8 million on raising two kids and paying off a house.

Entering your 30s without a strong financial base could be a disaster.

So don’t end up like Mr and Mrs Joe Average, with 2.5 kids, a huge mortgage, credit card and personal loan debts, struggling to make ends meet, worrying about how to pay the bills, stuck in a job you might not like that much and worried about what will happen if you become unemployed.

Saving in your 20s will make your 30s, 40s, 50s and beyond much more fun and you’ll probably live longer without all the stress. You also have the potential to retire when you choose, rather than be forced to work into your 70s – if you can find a job that is.

Why saving $10,000 in your 20s is better than saving $25,000 in your 40s

Here’s another example of saving and investing in your 20s and then doing nothing versus trying to do it in your 40s.

Simply saving $1,000 each year for 10 years in your 20s and then doing nothing until you retire at age 65 would see that $10,000 initial investment grow to more than $540,000. Trying to save $1,000 each year beginning in your 40s until age 65 would see you contribute $25,000 and have just $119,000 – assuming both generated compound growth of 10% each year. (10% is regularly used as an average return from the stock market over the long term).

The difference is clearly the number of years. Saving from age 20 gives you 45 years of compounding, saving from age 40 leaves you just 25.

I’ve included a link to the Google Sheet, so you can see the calculations.

Of course, you won’t get 10% from the stock market each year. In some years it will be higher and in some years it will be negative, but over the long-term, returns from the S&P/ASX 200 (Index: ^AXJO) (ASX: XJO) should average out to about 10% a year, including dividends reinvested.

Foolish takeaway

A simple tweak to your lifestyle in your 20s and a strategy of saving and investing from an early age should set you up well for later years.

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Motley Fool contributor Mike King doesn't own shares in any companies mentioned. You can follow Mike on Twitter @TMFKinga

Unless otherwise noted, the author does not have a position in any stocks mentioned by the author in the comments below. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.