The Magic Of Compound Interest

Here's a topic we've addressed before. It is a topic worth repeating. I took the simple explanation directly from the U.S. Department of Labor, Employee Benefits Security Administration.

Compounding investment earnings is what can make even small investments become large investments given enough time.

How It Works – The money you save (either in a savings account, a mutual funds or in individual stocks) earns interest. Then you earn interest on the money you originally save, plus on the interest you've accumulated. As your savings grow, you earn interest on a bigger and bigger pool of money.

Start Saving Early - For every 10 years you delay before starting to save for retirement, you will need to save three times as much each month to catch up.

Starting at 20 - If you put $1,000 a year into an IRA every year from age 20 through age 30 (for 11 years) and stop - and the account earns seven percent annually - your savings will equal $168,514 at age 65.

Starting at age 30 - If you don't start until age 30, but save the same $1,000 amount annually but for 35 years straight at the same seven percent rate, you will have saved three times as much money but your account will grow to only $147,913 at age 65.

Where you might obtain a steady 7% return puzzles me, especially in this low interest rate environment but the point is clear even on a lesser scale:
- Start early!
- Save regularly or automatically!

The difference is significant if you wait. Even small amounts saved early have many more years to grow.

Be $ Smart - Start saving now! Any amount is better than none. Your future depends on it.

The Tortoise and the Hare - $ Version

So many folks postpone saving for retirement "until I get on my feet". That day can be very illusive! Below is an example of how starting early gives you a head start towards a winning goal. ($5000 a year breaks down to $416.66 per month or $96.15 per week.)

Angie, age 30, decides to begin saving for retirement this year. She invests $5,000 a year and earns a constant 6% return. After ten years, she stops making contributions but lets the money remain in the investment, earning 6% annually, for her retirement at age 65. Dave, also age 30, does not begin to save for retirement until ten years later when he is 40 years old. From age 40 until age 65, he contributes $5,000 annually, earning a constant 6 percent return.

By the time Angie and Dave reach age 65, Angie will have invested a total of $50,000, while Dave will have invested $125,000. Intuitively, one might assume that Dave will have accumulated more. However, in 35 years, Angie will have a total of almost $225,000; Dave will have accumulated just less than $195,000.

Accumulated Amounts
Angie—$5,000 annual contributions for 10 years;
$50,000 total contributions
Year 1 $5,300
Year 5 29,877
Year 10 69,858
Year 11 Contributions cease
Year 15 93,486
Year 20 125,005
Year 25 167,419
Year 30 $224,045

Dave—$5,000 annual contribution beginning in year 11 for 25 years;
$125,000 total contributions
Year 1 $0
Year 5 0
Year 10 0
Year 11 Contributions begin
Year 15 29,877
Year 20 69,858
Year 25 123,363
Year 30 $194,964

The numbers in this chart assume all contributions are made at once at the beginning of each year; 6 percent interest is calculated and applied at the end of each year. Source: WebCE

The secret is compound growth over time. Dave put aside $75,000 more than Angie but had fewer years of the money building on itself - compound growth.

Be $ smart, start saving early!