Albert Einstein once said that he believed the best, most incredible thing ever invented was Compound Interest. We are all affected by compound interest in one way or another. It can truly be one of the biggest resources we have or one of our most dreaded enemies. Which will it be for you?
To illustrate the power of compound interest, let’s compare a hypothetical example of two savers—one who starts the process early, and the other who waits awhile. The first person begins saving at age 21. She invests $100 every month for only ten years, and stops the process on her 31st birthday. At that point, her total investment is $12,000, and she lets it sit, earning interest, until retirement at age 65.
The second person waits until age 35 to begin saving for retirement. She also puts away $100 every month, but continues to do so up until age 65. So her total investment is $36,000. Like the first person, she never touches a penny of the investment until her retirement.
So who ends up with more money? Intuition might say that the second person, who invested more ($36,000 instead of $12,000) would end up ahead. But the earlier investor has time and compound interest on her side. Assuming an annual return of 8%, compounded monthly, the first investor would end up with $300,053, while the second would only have $150,030. In other words, the first person would invest $24,000 less than the second, but would end up with $150,023 more!
Let’s look at a few more examples to drive this point home. Suppose that the first person, instead of stopping their investment at age 31, had continued investing $100 every month until retirement at age 65? There, her total investment of $52,800 would result in a nest egg of nearly a half million dollars: $489,120!
Now, take the example to the extreme. Let’s pretend you just had a new baby, and wanted to ensure a golden retirement for her or him. When baby is born, you begin depositing $100 every month into an investment account. You continue to do that until the child’s 6th birthday, at which point you stop. You leave the money in the account and never touch it. Again assuming the 8% interest rate, when the child retires at age 65, your investment of $7,200 would have grown to over a million dollars—$1,107,869!
Naturally, these are hypothetical examples and the results of your own investments may earn more or less than the amounts given. Also, taxes will have to be paid either on the interest as it is earned, or, if the investments are in a tax-deferred account, when the money is withdrawn. Those facts notwithstanding, the point is still worth noting. Starting today is better than starting tomorrow. Starting this week is better than starting next.
Aside from starting early, another major variable in the retirement savings process is the amount you save every month. Obviously, the more you put away, the larger your savings, and the faster your investment will grow.
With a carefully constructed budget, you will have an excellent understanding of your monthly income and expenditures. That knowledge will translate directly into how much you can afford for your retirement savings. Meet with a financial or investment analyst, or the Personnel or Compensation office at your place of employment, and begin your program. Make the savings a permanent part of your budget. Years from now, you will be so glad you did!
Hello everyone! I thought I should take a few moments to tell everyone who I am (and who I am not, for that matter).
First of all, I am not a Financial Advisor, CPA, or Lawyer. I am just a normal joe who has read a lot. I do have a finance degree, but that has little to do with the topics I will be discussing here. I enjoy learning new strategies of how to effectively plan my financial future. I am married to a beautiful woman, but we do not have kids yet. I am the Chief Operations Officer for a national Employee Recognition company based out of Wilmington, NC.
I started this blog as a hobby, but I would love it to become more than that. I want this to be a place where we can post questions and learn from each other’s experiences. Feel free to post comments and questions and I will do what I can to find an answer for you.
$2.2 Trillion
Total American consumer debt in 2005–more than twice the consumer debt in 1994.
Source: creditcards.com
-0.5%
The average personal savings rate in the United States in 2005–the first time this rate has dipped below 0% since the Great Depression.
Source: creditcards.com
70%
The percentage of American workers who plan to work in retirement.
Source: Employee Benefit Research Institute
40%
The percentage of retirees who will end up having to leave the work force earlier than expected due to health problems, disability, or company downsizing.
Source: Employee Benefit Research Institute
$12,000
The average amount of credit card debt paid off with home equity loans amoung middle class households.
Source: creditcards.com
A wise man once said, “If you fail to plan, you plan to fail!”. Many of us spend more time planning a vacation or a birthday party than we do planning our financial future. If you find yourself in this boat, its not too late! Start today by applying the steps below to help ensure that you are ready to enter the next stage of your life.
1. Imagine yourself in retirement, if money were no object, and answer the following questions. Where do you live? What do you drive? What type of lifestyle do you live?
2. Now that you know what you want when you retire, what would it cost each year to support that lifestyle? Take that annual income need and divide that number by .04. Are you sitting down? That is the amount you would require in savings in order to safely provide the income you need.
3. Are you there yet? Well, most other people aren’t either. Now it is time to buckle down and take control of your financial future. You must get your financial house in order. You must take a close look at where you are financially. How can you get anywhere if you do not know where you are? Make a list of all your debts; the balance on each account, the interest rate, and the amount of time left on the loan. Before you start serious saving toward retirement, you are going to get out of debt!
4. Once you have your list, you are going to prioritize the debts. List the debts from lowest balance to highest. You are going to take every penny not needed for necessary expenses and apply them to the bill with the lowest balance. Once that bill is paid, you will take that same “regular payment” along with the “extra payment” and apply that to the next bill on your list. The next thing you know, you have a snowball of money working to “clean your slate” of all debt.
5. Once your debt is gone, you will start sticking that huge amount of money each month into some sort of savings account. We will discuss different options for savings later.
What are you waiting for? You have work to do! Get up right now and start with step 1.