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!

This entry was posted on Thursday, March 22nd, 2007 at 2:49 am and is filed under Uncategorized. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.