The Opposite of Compound Returns

A while back, I wrote a well-received post on why it is so important to leverage the power of compound investment returns on your savings.

Here’s what I calculated, to make the case:

“$1 saved in your twenties can be the equivalent of $10 saved in your fifties, if invested over time.

$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).”

At the time, I thought “DAMN!”. I knew compounding was important, but the strength of those numbers surprised even me a little. And if they don’t inspire you to also save as much as you can as early as you can, then I give up.

Unfortunately, on a broader scale, benefiting from compound returns is not happening.

And not only is it not happening, but the opposite is happening. The millennial personal savings rate is -2%. This means that many millennials are not only not saving money, but that they’re actually increasing their interest-bearing debt.

opposite of compound returnsWhereas compound investment returns REALLY work to your benefit, the opposite is true of debt – it REALLY works against you. If it is revolving and you don’t pay it in full, it will compound against you. And with massive McMansion mortgage, $100K English degree, shopping spree credit card, and all-wheel drive loan debt working against you, it’s very possible that you could dig yourself a hole you might never crawl out of, if you’re not careful.

Americans will pay an average of $279,002 in interest payments over their lifetime. To emphasize, that’s not debt payments, that just the interest on top of the debt. The debt number would be much larger. In some states with higher housing costs (i.e. California, D.C., New York) total lifetime interest payments are well north of $300k.

With a median personal income of $31,099, that’s an average of 8.97 full working years just paying off interest on debt. Imagine that, 8.97 of the best years of your life going directly to a bank for the “privilege” of owing them money. And then there’s the lifetime of paying off debt as well.

While, it is true, that debt itself doesn’t compound (unless you are late in payment), every dollar devoted to paying off debt is one less dollar saved that can be leveraged for compounded savings returns. So, even if you keep your interest payments extremely low and pay your debt in full every single month, you’re still robbing your future self.

Here are a few examples on what you’re missing out on, in compound returns (at an 8% annual return):

Even at a conservative 6% return, it looks like this:

  • cable: $1,102,950
  • smartphone plan: $2,409,402
  • haircuts: $650,731

Just a few examples, but you (should) get the point. Imagine the numbers when you’re talking about the cost of vehicle and home upgrades, versus comfortable necessities. Coming to realizations like this is why:

Everyone has to spend money. But when you do, remember the following:

  1. Make it count. Ask yourself if this expense is truly worth the present cost. Is it going to make you happier or at least add significant functional value?
  2. Remember, it’s not just present cost, but also future value.
  3. If you are going to limit your savings, avoid debt at all costs.

You may not thank yourself today (and you’re probably cussing at me for ruining your day), but you’ll definitely thank yourself later.

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