The Power of Compounding Interest
For savers, the definition of compound interest is basic: It’s the interest you earn on both your original money and on the interest you keep accumulating. Compound interest allows your savings to grow faster over time.
Another way to say it? You put away a little money at a time, starting early in your career, and invest it. Historically, the market goes up, meaning your money should grow exponentially over time.
WHY IT’S A GOOD IDEA TO START EARLY
The simple answer is the longer your money is invested, the more time it has to grow. When it comes to compounding returns, time tends to be an advantage. No matter how much you contribute, the key is to contribute regularly and start early.
Check out these two compound interest examples to see how it works in real life.
Hannah is 20-years-old and invests $1,000 today. Assuming she does not touch it until she retires at age 70, her money could increase by 32 times or $32,000. (Assumes a 7.2 percent growth rate).
If Hannah waits just ten years to invest that same $1,000, she would only end up with about half, just $16,000.
Taking this one step further, if Hannah invests $1,000 at 20 and contributes $83/month, she would have $465,000 at age 70. If she didn’t start this process until age 30, she would have approximately $225,000.
Harlow is 25-years-old, and Harrison is 45-years-old. They each save $30,000 over 20 years. (Assuming a 6 percent annual return).
Let’s say that Harlow starts saving at age 25 and stops at 44, while Harrison starts at age 45 and stops at 64. Even though they saved the same amount and earned the same rate of return, when Harlow turns 65, she’ll have $110,000 more in her nest egg than Harrison when he turns 65. Why? Because Harlow’s money enjoyed up to 40 years of growth from the power of compounding interest.
THE BOTTOM LINE
The sooner you begin saving for retirement, the better. When you start early, you can afford to put away less money per month since compound interest is on your side. Compounding interest benefits those who invest over long periods the most.
DEVELOP YOUR FINANCIAL STRATEGY
A comprehensive financial plan can help you make sound investment decisions and prepare for retirement. Contact one of our financial advisors today to develop a strategy right for you.