“Compound interest is the eighth wonder of the world. He who understands it, earns it… he who doesn’t… pays it.” — Albert Einstein
When I was in my early 20s, I read an article about compound interest that really stuck with me. The writer said that if you put away $2,000 a year from age 22 through 30, and then never add another dime, you would have more money at the retirement age of 65 than someone who put away $2,000 a year every year from age 30 through 65.
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Compound Interest: A Real Life Example
Math is not my friend. I am great at many things, but math doesn’t even come close to making the list. So the scenario above didn’t make any sense to me. Twenty-two through thirty is 8 years. Thirty through sixty-five is 35 years. So it’s $16,000 vs. $70,000, and the $16k wins? I didn’t believe it. So I went to the Dave Ramsey Investing Calculator and plugged in my numbers. Let’s check them out:
In this first image, you can see that I contributed a total of $16,000.32 or $2,000.04 a year for 8 years. Then I stopped contributing — but the money kept growing to a grand total of $707,041.40!!! Wow, that’s a lot of money. But surely if I put more in for a longer time, I will have more, right? More is more. Let’s take a look at that chart:
In this image, you can see that I contributed $70,001.40. That is more than 4 times the amount contributed in the first scenario. I contributed four times as long, and my total is $596,265.38. That comes out to $110,776.02 LESS than the first scenario. Contributing more to earn less sounds like the losing strategy to me. I guess Mies van der Rohe was right. (He’s that architect who said, “Less is more.”)
So let’s go back to that initial article, which compares 22-30 vs. 30-65. What happens if we combine those two and start contributing at age 22 and then never stop?
A whopping $1.3 million, simply by putting away $166.67 every month for retirement. Now imagine how much you would have if you increased your retirement savings whenever you got a raise? (If you put away $255.77 every month, your total is over $2 million.)
Check out this pie chart below, which shows how much of that total is interest! Turns out 93.4% of that $1.3 million is interest! It is actually really hard for me to wrap my head around how little of that total came out of my hypothetical pocket and how much came from investments, which in essence funded my retirement.
Something many people don’t consider is that the best time to start investing is right out of college. You are just exiting a time in your life when you had no money. Once you get a job and the money starts coming in, most people start spending it to either make up for when they didn’t have anything, or to keep up with the Joneses.
But what if you continued to live like you had no money?
Live Like You Did in College
In college, you probably had a roommate (or three) to share expenses. Ramen noodles was a staple of your diet, and you rode your bike around campus because you had no car. What would happen to your bank balance if, instead of finding your own place once you got a job, you continued to live with roommates who helped share your expenses? Better yet, how far ahead would you be if you bought a house and rented the extra rooms out?
Potentially, your roommates would pay your mortgage, freeing up your money to work for you even more by allowing you to pay off student debt, consumer debt or even allowing you to purchase another property to rent out. If you were lucky enough to have a car in college, it would do just as good a job getting you to work as it did getting you to class. Resisting lifestyle inflation is a powerful choice that may make you a multi-trillionaire* some day.
Compound interest is a ridiculously powerful tool in your retirement arsenal. But you have limited time to take advantage of it. The earlier you start, the more you will have. Even Albert Einstein believed in the power of compound interest. Have you started saving for retirement yet? What is stopping you?
*Not guaranteed to happen.
**Featured image by Underwood and Underwood, New York [Public domain, Public domain or Public domain], via Wikimedia Commons.
[Editor’s Note: We are republishing this article to help out readers newer to the BiggerPockets Blog.]
Are you using the power of compound interest to help prepare for retirement? Have you passed on this lesson to your kids?
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