If Albert Einstein offered you investing advice, would you listen? He once said, “Compound interest is the eighth wonder of the world. He who understands it, earns it; he who doesn’t, pays it.” As with many topics Einstein discussed, compound growth can be difficult for most of us to comprehend. However, it is essential to building long-term wealth through investing.
There are two types of interest. The first is simple interest, which is paid on the principal only. The second is compound interest, which is paid on both the principal and the accumulating interest. Compound interest is your money working for you-in addition to earning a return on the principal that was invested, you also receive a return on your earnings.
Time is the biggest component to successfully building wealth through compound interest. The more time you have to save and invest, the more your money can work for you and grow. Therefore, it is important to begin investing as early as possible. Next, we will explore some examples depicting the power of compound interest.
First, let’s say you are 18 and you plan to retire when you are 65. This means that you have 47 years to save and invest. If you put $200 a month under your mattress for 47 years, you will have saved $113,000. If you save the same amount but have an average annual return of 7%, compounded annually, you would end up with $794,947 after 47 years. That’s nearly a $682,000 difference, from saving $200 a month!
Secondly, we will compare three friends who started investing at different ages:
Lisa saved $1,000 per month from the time she turned 25 until she turned 35. Then she stopped saving but left her money in her investment account where it continued to accrue at a 7% rate until she retired at age 65.
Mark held off and didn’t start saving until age 35. He put away $1,000 per month from his 35th birthday until he turned 45. Like Lisa, he left the balance in his investment account, where it continued to accrue at a rate of 7% until age 65.
John didn’t get around to investing until age 45. Still, he invested $1,000 per month for 10 years, halting his savings at age 55. Then he also left his money to accrue at a 7% rate until his 65th birthday.
Lisa, Mark, and John each saved the same amount — $120,000 — over a 10 year period. However, at 65 years old Lisa accrued $1,444,969. Meanwhile, Mark earned $734,549, and John had $373,407.
In summary, investing as early as possible and using that time to accrue interest is an important component of building wealth. If you are interested in running compounding interest calculations, the U.S. Securities and Exchange Commission (SEC) has a calculator you can utilize: https://www.investor.gov/financial-tools-calculators/calculators/compound-interest-calculator. Our team at Laws Financial would like to help you harness the power of compound interest. Call us today to get the conversation started!
