$1 saved in your twenties can be the equivalent of $10 saved in your fifties, if invested over time.
Hard to believe? It’s true.
Actually, $10.06 to be exact – at an average annual rate of return of 8% on your investments over 30 years. Even if you factor in 2% annual inflation, you’d have 556% of the buying power for every dollar you save today.
Alternatively, if not invested, every dollar you stick under your mattress will still only be worth a dollar (and just $0.55 in buying power).
Those numbers sum up the power of compounding investment returns and should thrill you, if you are a young investor. If you haven’t been investing much, the missed opportunity should scare the crap out of you!
To hammer home the point further, take this example from Burton Malkiel, the author of A Random Walk Down Wall Street, as he highlighted the following example of compound interest in action:
“William, starts saving $4,000 a year when he is 20 and stops after 20 years, after having saved $80,000. His brother, James, starts saving $4,000 at 40, and does so for 25 years, for a total of $100,000 saved.
They earn 6% on their savings.
At age 65, William will have $850,136 in his account, while James will have only $219,242. Despite having saved less, William’s nest egg will be almost four times greater because of compounding.”
And that’s at just a 6% return. An extra 2 percentage point increase would more than double William’s account.
This scenario is reason #1 for why you should save early and often. In fact, just starting at age 25 vs. 35 can lead to 2X the retirement savings from compounding.
The problem is that the millennial personal savings rate is -2%. So why don’t my twenty and thirty-something peers do it? The two most cited reasons I hear are:
“I have plenty of years ahead to save. There’s no rush.”
and
“I have a lower income now than I will in a few years/decades.”
On the first, I hope that the first part of this article inspires you to shoot down that excuse. You need to get in the habit of automatically saving a portion of your income as soon as possible. And the more you can boost your personal savings rate, the better.
On the second, I understand that it’s not easy to save when you’re just starting a career. You’ve got student loans, rent, all kinds of crap you think you need to buy, and outside of a few professions, you’re probably not making a huge income. Life is harsh!
But the reality is that every dollar you save in your twenties, you will be thanking yourself for many times over later on.
And if you think it’s stressful to carve out savings when you are younger, imagine having to work decades later than planned, having to save much more, yet knowing that the entire time that you’re still probably going to come up short of what you will need to finance a comfortable retirement.
Here’s a compound interest calculator, if you’d like to have some fun with numbers and see what you might be missing out on.
Also, the opposite of compound returns is equally as powerful (in a bad way).
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I like your post and agree with its theory, however, the problem I have with this article (and similar articles that I see all over) is that a 6% (or 8%!) compounded return is not a reasonable assumption anymore. Sure, MAYBE, if you invest 100% in equities and luck out to not have a recession when you are entering retirement, then MAYBE 6%. However, most people will not invest entirely in equities, especially not all the way through their 40 years of investing right up until retirement. This makes your reasonable assumed return around 3%-4% if you are a savvy investor. Take into account inflation and you’re only making about 1-2% effective interest.
Now, I’m really not all Debbie Downer, I do appreciate the point of saving early and I personally do everything I can to save anything beyond necessary expenses. However, I get frustrated by posts like this that use that as an assumption because its simply not feasible. Especially if you want any type of security in your portfolio against the markets. How about a post on how young people can invest in high-yielding, but safer municipal bonds or other instruments and get a modest return while still protecting their principal?
I disagree.
The historical market return on equities is around 12%. A 6-8% return on equities is completely feasible, and not overly optimistic in any way. In fact, it’s purposefully quite conservative, from a historical standpoint.
And if you are in your twenties, that is the time to be invested in equities vs. CD’s or Treasury Bonds.
Could the return be less than 6%? Sure. But to claim that equities will only return 2-4% over the next 3-4 decades moving forward is quite pessimistic and does not prove out, in a historical sense. If you have a magic crystal ball, please share with the rest of us.
Besides…. what’s the alternative you’d rather see people take up? Piling everything in to a CD or treasury bond that yields 1-2%?
I’ve been investing since about November 2007 and am earning an average of over 9% annually. I know that’s short compared to thirty plus years, but I’m off to a great start.
P.S. if I wouldn’t have gone on the defensive last June, and put most money in cash for a nearly a year, it would be over 10% annually.
That’s absolutely right.
Historical returns from equities have annually been at those levels, and if we’re talking about LONG TERM growth starting in your twenties, the point is to get invested and stay invested. If you’re investing in companies that have the balance sheet and the competitive advantage to succeed even through a bear market, your returns over the next few decades will not leave you disappointed.
Take a page out of Buffett’s book. Stay calm and compound invest.
I disagree with this outlook. I have been investing since 2004 in index funds and my average return has been greater than 8%. Historically, returns have been much higher. Even the safe withdrawal rate for retirement accounts, which is based on the worst-case scenario in history allows for 4% withdrawal while still preserving principal. That indicates an average return of 7% over 30 years. I think stating anything lower than 7% average annual over the long term is unrealistic. This article using 6% is exceptionally conservative. Many use 10% or 12%. I base my projected returns on 8% and have consistently returned higher than I expected.
Haha, a 6-8% annual return isn’t a reasonable expectation anymore? In my experience trading, if I am not getting at least a 5% return per month, then something is seriously wrong and the markets better be down over 1,000 points. Today the DOW was down over 300 points and I still made a 2% return on my portfolio. If people aren’t willing to learn how the markets really work and how to develop a solid plan for success, they deserve to lose all their money. Plain and simple. I will be there waiting to buy your losing shares from you.
Investing will always make sense because the average human would rather have a dollar now than two dollars later.
Unless human nature changes, those that practice deferred gratification will always win.
I certainly believe in the power of compound interest. I taught my younger workers this concept but found it doesn’t take hold in younger people. Instead, not after three days when I spoke to my small group about compound interest one of the guys went out and purchased a 4-door Jeep.
As for me I started putting money away immediately upon college graduation. I disciplined myself to invest a small chunk of money every month. Within a few years I made enough to max out my Roth. A few years later I made enough to max out my employer-sponsored savings plan. Then I put an additional sum into taxable index funds.
I’m glad I started early because my portfolio’s value is skyrocketing thanks to compound interest. I’m in my late 30s and my portfolio value is $900,000. I preach compound interest to any young person who is willing to listen.
Wow, excellent job on where you’re at in your 30’s!
Can anyone tell me actually how to invest and get compound(which I assume comes in different time slots) interest?
Also, just a quick note about spending vs. saving (no need to reply to this concept). If everyone saved the way we all want to on this website (assumption), what do you think the economy would look like? You think it would be healthier for our economy if people would begin to save at a higher national savings rate than our current 3-4%…what do you think employment would look like if we ALL saved the amount that people like us try to achieve? (btw, i am a saver so I’m not trying to preach, just food for thought and for everyone to look at the holistic view point of our economy and our species)
thanks if you can answer my main question about how to actually get compound interest.
Any time you earn money on gains (not principle invested) you are basically earning compound interest. So reinvest your gains and you’re earning compound interest.
So where can I find hi-interest (or low) compounded on a monthly basis. I have other investments that payout quarterly and I reinvest those dividends.
Any time you earn money on gains (not principle invested) you are basically earning compound interest. So reinvest your gains and you’re earning compound interest.
See Natalie’s and my response to Alyssa. There are plenty of compound interest calculators out there (one I linked to) if people want to crunch different numbers.
You need to factor in a much higher inflation figure. 3.5% annual is the historical average.
We are in a period of very low inflation now but that’s bound to change as the economy continues to heat up & credit is bound to get easier to get than it currently is.
But maybe I guess I just need a reason to spend more.(Don’t worry, I currently save too much)
Hi G.E. solid concept and presentation. One small mathematical correction. In the opening example it is true that you would have 5.56 times as much purchasing power. However, this equates to 456% more rather than the cited 556%. (In the same way that 2 times equals 100% more rather than 200%). Thanks for the post.
Ah yes. Changed “more” to “of the”.
The percent is the problem, not the phrasing.
i.e. $1*1.08^30 = $10.06.
$10.06 / (1.02^30) = $5.56 (which is 5.56 times the buying power, but not 556% of the buying power)
In the same way, $1 * 2 = $2. This is 2 times as much, but not 200% – rather it’s 100%. To calculate percents you must deduct 1.
$5.56/$1 = 5.56. 5.56 x 1 or 100% (of original buying power) = 556% of the original buying power.
If the phrasing was “more than”, you would be correct and need to subtract the original. But “556% of the original (1X) buying power” is the same thing as “5.56 times”.
So any examples of monthly compound interest investments?
One problem with compounding is that its takes either a lot of money or a lot of time to get rich. Doubling a $1,000 only makes you a $1,000. Whereas doubling a million in the same market makes you a $1,000,000. If you do start with a small amount you often have to wait 30-40years worth of compounding before your money is at number that is worth getting excited about. Unfortunately for me waiting half a human life for riches to come seems like a slow process to me!
Yes you make a good point. You need money to make money in the market.
But the earlier you start, the more likely you will have the big numbers you need when approaching retirement
Reciprocal link comes in which type.I want to know is that good to have such kind of links with the site or not…………….??As i have used reciprocal links with and I want to go with the best strategics..
We read about the power of compounding all time but I personally never get bored of the subject and seeing the numbers only motivates me further. :)
BTW…Not too sure why people get so caught up in the specifics around the subject. The bottom line is the earlier you start the better. Just means you are allowing more time for your money to compound and grow. :)
Compounding doesn’t make it take longer to make money, it makes it much, much faster. If you are buy and hold, then you are just wasting your money because all you can do is wait and hope for appreciation over 30-40 years. Sure you can reinvest dividends, but that doesn’t amount to hardly anything. Also, only about 20% of the companies that were around 40 years ago are still around today. What about 40 years from now? Are you willing to risk 40 years of your money on a 20% chance of keeping it? Dividend stocks are for people that have already grown their money and want regular income. Do not use them to do the growing, that’s foolish, and a misappropriation of investment capital, when talking about equities. If you want to buy and hold, choose real estate, or fine wines, or art. If you want really grow your money in the markets, you need to trade. It’s how the markets were designed to be ultilized and how you can make the most money. A trader has control over their compounding period. I don’t care about annual appreciation. Every time I exit one position and reinvest into another, I have compounded. Sometimes I might compound 2-3 times a month, sometimes 10. Depends on my positions. But either way, the more you can compound, the more you will make. I am up 60% year to date and I haven’t had a trade return more than 14% all year. Most trades are in the 4-6% gain range. I also limit myself to 1% losses on losing trades. If you are going to invest, then take the time to educate yourself well, make a solid plan of attack and then follow through and be honest with yourself. Stop listening to advice from anyone that doesn’t have a steak in your success. They are a waste of your time, or they are just taking your money.
stake, lol
Young people should definitely read this article and often as a reminder.
Nice write-up on compound returns. This is going to sound silly–so don’t judge too much ;)–but what steps should I take to get better returns on my portfolio? I have my Roth IRA through Vanguard (2050 TRF: VFIFX) and it’s averaging around 7%. This is no where near the 10%+ returns that some people are mentioning. I started this when I had close to zero knowledge about investing and have simply stuck with it. Now I’m a bit worried that it was the wrong choice.