The Magic of Compounding
Compound interest is the best friend of a young investor, and by young I mean anyone who will be saving for more than about 20 years. Which is probably everyone under the age of 50. The ability to earn interest on your interest can over time turn a small amount of money into a large amount of money, if there is one thing you need to know as an individual investor it is the advantage of putting your money away and letting your interest earn interest.
Fundamentally the concept is so simple, but the effects are so powerful. Take $1000 invested at 10% with earnings reinvested and see how much you earn every year.
- Year 1: $100
- Year 2: $110
- Year 10: $236
- Year 20: $613
- Year 30: $1586
- Year 40: $4114
Without putting another dollar away after 26 years you are getting a return equal your original investment.
As you can see there is huge money to be made by putting cash aside and not touching it for a number of years. The advantage of compounding is lost if you spend the investment returns, or dig into the principle. The advantages are also lost if you wait to long to start. This is why waiting until you are in your 40’s to begin saving for retirement makes thing much more difficult than if you start in your 20’s. That extra 20 years of compounding can make a huge difference in the size of your retirement savings and the earnings those savings can throw off during your retirement.
It is the magic of compounding that allows people in their 20’s to become wealthy with a small amount of savings every month. The compound interest on those small amounts can add up to a very big pile of cash over a number of years.
So don’t delay, begin saving today, even small amount now will pay off big later due to the magic of compounding.
April 23rd, 2007 at 4:52 pm
[…] Because of the magic of compounding we now have $8441.28 growing for the next 20+ years simply by putting that money in early rather than later. If we had waited to fund our Roth IRA we’d have missed that gain. But remember those folks who waited to fund their 2006 contribution until April 15th missed that $441 gain, but they missed it with both their 2006 and 2007 contribution. Thus my wife and I are $882 richer because we funded early in both 2006 and 2007 than if we had waited until the last minute. And it’s all tax free, my favorite kind of money. […]