We hear frequently that young people should start contributing to an RRSP early in life. Recently, I encountered yet another of these arguments. However, there are some unrealistic expectations buried in the assumptions used.
Here is a typical version. If you start contributing $500 per month to an RRSP at age 25 and make an 8% return each year, you'll have about $1.7 million by the time you're 65. But, if you delay making contributions until you're 35, you'll only have about $800,000 at age 65. This is less than half as much.
The math is right. The contributions during the first decade really do count for more than the remaining three decades because of the magic of compound interest. However, there is a serious problem with the built-in assumptions.
Let's look at this from the point of view of a 65-year old who is just making his last $500 RRSP contribution and is about to retire with $1.7 million. Supposedly, he made $500 RRSP contributions each month starting 40 years ago. But what about inflation?
If we assume inflation has averaged 4% per year over those 40 years, that first $500 contribution when our retiree was 25 years old is the equivalent of $2400 today! How many 25-year olds do you know who can contribute $2400 per month (or $28,800 per year) to their RRSPs?
I'm a believer in saving money from a young age, but the typical justification of the type I described here is hopelessly flawed. Your early years of saving are important, but not quite as important as they can be made to seem.