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Compounding Interest & Retirement: How Starting Early Pays Off Later

3 min read

30 sec brief

Have you ever wanted a way to grow your wealth without having to save more money? There is a way to grow your hard-earned money, it’s called compound interest. If you use it correctly, it can expand your retirement savings significantly.

You can’t go anywhere these days without being told to save for retirement. There’s ad’s on the sides of buses; almost every commercial break includes something on the subject, and social media will remind you - in case you forgot!

Have you ever wanted a way to grow your wealth without having to save more money? There is a way to grow your hard-earned money, it’s called compound interest. If you use it correctly, it can expand your retirement savings significantly.

What is Compound Interest?

Most savings accounts accrue interest in some form. Many accounts use simple interest, which is calculated on the principal amount. While your money will grow, it doesn’t happen very fast.

This is where compound interest comes in. Compound interest is calculated on the initial principal as well as the accumulated interest from previous periods. It’s like your principal amount earns interest, and then the interest earns interest too! It allows your wealth to rapidly snowball, and enables a deposit to grow at a much faster rate than with simple interest.

Why it's Good to Start Saving Early

There are a few factors that combine when it comes to saving. The amount of money you save is a big part of the equation, but the magic ingredient is how much time you let that money work for you.

If you leave an investment untouched for several years - we’re talking decades here - it can add up to a considerable amount of money with compounding interest, even if you never invest more than the principal amount.

The reality is that the longer you can let your money work for you, the better. Let’s look at an example of how compounding interest can work.

Todd always knew how important it was to save for retirement. At age 28, after attending college and getting a job, he focused on saving for his golden years. He began investing $5,000 a year from age 30 until he retired at age 60. Over the 30 years, he invested a total of $150,000.

In this example, he earned a seven percent annual investment return on his savings. After 30 years, he had over $500,000 in his account, even though he only invested $150,000.

Here’s the best part, if someone follows this same formula and begins investing at age 18, their account balance will be significantly higher, potentially over $1,000,000 by the time they retire!

It’s all due to the snowballing effect that compounding interest has!

Compound interest works best over time, though it’s never too late to begin growing your wealth.

When you’re starting out, many expenses compete for your money, like student loans, saving for a home, credit card debt, and many more. However, it is vital to start thinking about how to fund your golden years, and getting an early start can help you retire stress-free!

How to start

Beyond time, consistency is the next most crucial piece of building wealth. Here are a few ways to get started today:

  • Contribute to your employer-sponsored 401(k). If there’s an employer match, be sure to do this as that’s free money for you!
  • If you’re self-employed, contribute to a SEP IRA. Though you won’t get an employer match, the contributions are tax-deferred.
  • Contribute to a Roth IRA (contribute up to $6,000 in 2019 with an additional $1,000 for ages 50 and older).
  • Determine an amount to keep in an HSA account for medical expenses and invest the extra contributions.

At the end of the day, it’s just important to start! No matter where you are on your journey today, take time to start saving for retirement. Even a small amount like $25 a month will add up over time.

The power of time makes compound interest so effective. Start saving now and you will see the rewards in the future. The key is to start!

Disclaimer: the content presented in this article are for informational purposes only, and is not, and must not be considered tax, investment, legal, accounting or financial planning advice, nor a recommendation as to a specific course of action. Investors should consult all available information, including fund prospectuses, and consult with appropriate tax, investment, accounting, legal, and accounting professionals, as appropriate, before making any investment or utilizing any financial planning strategy.

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