The Power of Compounding Returns, and the Importance of Starting NOW!
“The most powerful force in the universe is compound interest.” – Albert Einstein”
Well, of course it makes sense that we should start investing sooner so that we can retire more comfortably. However, most people fail to realize just how powerful compounding can be, and what a difference it can make in our long term financial health.
So, what do I mean by compounding? In its simplest form, compounding is simply the phenomenon of earning interest on interest. If I have $1.00 in my savings account that is earning 2%, at the end of the year I will have $1.02. That means that in the following year, I earn 2% on my original $1.00 and on the $0.02 in interest. In small numbers over small time frames, the impact is negligible. But what is the impact on larger amounts over a lifetime of saving for retirement? Let’s take a look at the math.
Let’s assume that you start saving for retirement at age 35. You save $300 per month, and let’s conservatively assume you earn an annualized return of 5% per year. In 30 years, at the age of 65, you would have $249,677. But what if you had started earlier like so many retirees advised? If you started at age 25, and made the same $300 monthly investment earning 5%, you would have $457,806! But, you say, I can’t afford that $300 when I am young. Let’s look at it another way. If you wanted to wait until you were 35, but still wanted to reach that $457,806 in savings, you would need to save about $550 per month. Now you see why Einstein was so impressed.
While some people may be motivated by optimism, others react to fear. What if we look at this the other way? Instead of starting at age 35, what if you didn’t get around to starting until age 45? Investing that same $300 per month at 5% only nets you $123,310. Getting back to the $249,677 would mean saving more than double at $607 per month. And reaching that $457,806 if you start at age 45? That would take about $1,114 per month. So get started as soon as possible – no matter what your age is now, time is your biggest ally in reaching your goals. You can see it in the savings graph below, where the balances really take off in the later years. Why is that? Simple – you have a lot more time to earn interest on your interest. The time to start is now! Why wait? Need help figuring how much you can save? We can help!