Yes, my friends, there is a miracle among us! Believe it. It can transform our little nest eggs into great big ones. It can empower us to retire and send our kids to college and maybe even travel in our old age. It’s called compound interest. And, the sooner we embrace it, the greater our reward.
Skeptical? Well, here’s how it works. Money invested can earn interest. Interest earned on our capital the first year is called simple interest. After the second year, we earn interest on both our capital and the simple interest earned the first year. That’s compound interest. It’s interest earned on interest. The third year, we earn interest on interest on interest. Our investment just continues compounding exponentially like this into eternity… or retirement. The longer our money stays invested, the more time it has to experience the miracle of compounding. Every 10 years, at an 8 percent return, our initial investment more than doubles. And, if we add regular monthly contributions to it, our investment way more than doubles. Growth over the first 10 years may not appear major, but our third or fourth decade’s increase could be dramatic. We only get that far, though, if we start early enough.
Let’s talk dollars. Exactly how much difference does an early start make? Let’s say we begin at age 25 investing $150 a month at 8 percent. By the time we’re 35, we’d have $28,000. At 45, we’d have $89,000. At 55, $220,000. At 65, we’d retire with $503,000. But, if we don’t start until age 35, that same $150-a-month investment only gets us as far as the $220,000 mark by 65. What a difference a decade makes! So, what if age 25 has come and gone? What do we late-starters do now? Well, we don’t panic. We plan. And, first things first, we save. Is there waste we could squeeze out of our monthly budgets? Could we postpone some luxury purchases? Are we living beyond our means? These are difficult questions to be sure. But, the sooner we face facts, the sooner we can start socking it away. And, the sooner, the better.
Once we have savings, we have options, though they’re not without compromise. To hit our 25-year-old’s $500,000 mark, we could seek higher — though riskier — rates of return. A higher 10 percent return would lower the 35-year-old’s monthly contribution to $235 from the $345 needed at 8 percent. Or, we could keep the 8 percent rate and instead delay full retirement. A semi-retirement plan would let us stop making contributions at 65. But earning enough to cover expenses for another five years could make all the difference. This would cut the 45-year-old’s monthly $845 to a more manageable $575.
If we have the will, we can find a way. Wherever it is we stand now, our key to success is to take the most advantage of compound interest as we can. Because when we do, it can indeed work miracles.
What’s up next? Managing Debt
Berry is not a Certified Financial Planner. She is the self-taught manager of her family’s finances and a cum laude graduate of Texas Tech Law School. Before making any financial decisions, evaluate all information carefully and consider consulting a financial professional.