Starting Early – The Ridiculous Math Behind Compound Interest

When it comes to investing for retirement, there’s no such thing as starting too early.

Compound Interest      

            Compound interest is the driving force behind all great sums of money. It refers to the interest earned on interest from a previous period – the result of reinvesting interest instead of paying it out. If you invest $1,000 and generate a 6% return, your ending balance is $1,060. If you generate another 6% return, your balance becomes $1,123.60. The additional $3.60 you earn the second year is compound interest, the interest earned from the previous period’s interest ($60 x 6%).

It’s a simple concept with powerful implications, which is why Albert Einstein is quoted saying “Compound interest is the eighth wonder of the world. He who understands it earns it, he who doesn’t pays it.”

Saving a Little Early vs. Saving a Lot Later

            So, how do we apply it? Let’s say you start investing $400 per month, generating 8% per year for 40 years. Your friend, Tony, who is the same age, starts 20 years later, and invests $1,500 per month at an 8% rate for 20 years. You both retire on the same day – who has more money?

            Your $400 per month has become nearly $1,243,000. Congratulations, you’re a millionaire, with only $192,000 in contributions.

            Tony’s $1,500 per month has become $823,715. Nothing to scoff at, but considering his $360,000 in contributions, you wouldn’t exactly want to trade places with him.

            What about Cindy? She waited 10 years after Tony started, but contributed $5,000 per month at the same 8% rate. After contributing $600,000 in a mere 10 years, Cindy only ends with a balance of $869,194.

            Neither you or your two friends will have a bad retirement, but who do you think enjoyed the process more? Who was less stressed in getting there?

Finding the Money

            Already living paycheck-to-paycheck? Wanting to put aside a portion of your income to invest but don’t know where to get it?

  • Start at 1%. 

Simply beginning the process of saving for retirement is a huge step, no matter how much you’re contributing. Increase your contributions slowly from there, quarterly or annually, and you’ll hardly notice a difference in your paycheck. 

  • Invest a portion of each raise

A great strategy for leaving your paycheck completely unaffected – take a percentage of your salary increase and add it to your payroll deduction. Receive a 10% pay raise this year? Have your HR department set aside half of it to be added to your 401(k) every month. Your take-home pay will still increase while your retirement contributions are also expanding.

Starting Late?

            Despite it being far easier to build a sizeable nest egg when starting in your 20s, it’s not the only way. If you have less time to save for retirement, you will simply need to save more in order to reach the same target. For example, for a goal of $1 million at age 65:

            Starting at age 20, save $4,500 per year

            Starting at age 30, save $9,000 per year

            Starting at age 40, save $18,000 per year

            Starting at age 50, save $40,000 per year

(*Assuming an annual 6% return)

            Regardless of where you’re at and where you’d like to be, starting today will always be better than waiting.

Closing Thoughts

            Nearly all employers offer some sort of retirement saving program (401(k) or 403(b) being the most common), with many employers offering to match their employee’s contributions. Take advantage! This should be seen as part of your salary – if you don’t utilize it, you’re leaving money on the table.

The number one reason people give for not starting to save for retirement is that it seems so far off. However, what you’re doing isn’t just saving for retirement, it’s accumulating wealth – and no one is ever too young for that. It’s true, the money is meant to be used at retirement age, but accumulating wealth becomes incredibly simple, inevitable even, with time on your side. 

Do your future self a favor: start now and don’t ever stop, the math doesn’t lie.

*Tip: Check out this calculator to see how your money can grow using the power of compound interest.

Share this post

Share on facebook
Share on google
Share on twitter
Share on linkedin
Share on pinterest
Share on print
Share on email
Planning

Cash Value or Term Life Insurance – Which is Best for Establishing Legacies and Protecting Your Loved Ones?

The odds are that your idea of a good time does not include shopping for life insurance. As depressing as thinking about your death may be, studies show that everyone dies! Life insurance is a great way to make sure that you leave a legacy, rather than a burden to the people you love. Deciding whether a cash value policy or a term life policy best suits your needs is the first meaningful decision you will need to make when shopping for life insurance plans. If you find yourself stuck in the middle of this debate, here are some things to consider.

Read More »
Finance

Impact Investing

Investing is no longer just about returns. Investors are increasingly looking for their money to make a positive impact on the world.

Read More »