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Actions Time Is on Your Side: Compound Interest and Your Retirement
Key takeaways
- The sooner you start investing, the more compound interest you can earn.
- It’s fine to take baby steps up the contribution ladder, investing a little more each year.
- Let your time frame guide the amount of risk you take.
A $1 million retirement nest egg might sound unattainable. But you, too, could grow your retirement savings—even if you currently have a modest income.
When you’re young, one of the most valuable things you have on your side is time. Time allows compounding to work its magic. As you earn returns on your investments, those returns have the potential to earn greater returns, and so on. The earlier you start, the more time your money has to compound.
Compound interest can help grow your funds year over year through accumulative interest. For example, if you earn 5% yearly interest on $1,000, you’ll earn just over $276 over the course of five years. Just imagine: If you invest an extra $1,000 per year, for 50 years, you could save as much as $220,000. That’s why starting to invest early is crucial to building your nest egg and saving for the future. Waiting may end up costing you in the long run, and compound interest can help you save.
Ready to watch your money grow?
No time like now
It’s impossible to overstate the importance of early saving and investing. When you start early, you can invest much less to potentially build the same nest egg you would if you started at an older age. But it can be tricky to carve out the money for saving when you’re first starting out. Between student loans, rent and groceries, you might not have much left at the end of the month to invest.
Fortunately, there are some ways to make saving a little less painful:
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Pretax perks:
You’ll likely miss your money a lot less when it comes out of your paycheck before it’s taxed. Most workplace retirement accounts are funded pretax, which can really boost the incentive to save. -
Put away a little at a time:
You don’t have to fund your entire nest egg all at once. The task is much more manageable when you work on it over many years. However, the more you save, the faster you’ll reach your goal. If you're under age 50, you can contribute up to $19,500 Opens in new window to your workplace retirement account in 2021. While it may be tough to put away that much, try to increase your contribution every year—perhaps after you receive a raise.
What it takes
How you invest will depend on your level of risk tolerance. Generally, the higher the potential for gains, the more risk an investment involves. How do you feel about risk? Will you be able to ride out periodic and inevitable investing declines, or will you want to duck for cover?
If you can stomach a lot of risk, your portfolio can be more aggressive. Although past performance doesn't guarantee future results, growth-oriented stock focused portfolios have been shown to produce higher returns over the long term and could be suitable for investors with a high risk tolerance.
Here’s a hypothetical example that drives home the point that the more time you have, the less you have to put away each month to reach your goals: Emily is 25. By saving $440 a month, her nest egg will top $1 million by the time she’s 67, assuming a 6% average annual return on her investments.
Her 25-year-old friend Elliot, on the other hand, decides to wait five years before investing. He’ll need to put aside $613 a month, assuming a 7% annual rate of return, to have the same portfolio at age 67. In the end, Emily will have paid $50,412 less for her $1 million nest egg.
Just five short years can make a big difference. That’s quite an incentive to start saving at as young an age as possible, isn’t it?
What you can do next
Achieving a seven-figure nest egg is a matter of time, tempo and temperament. The key is to make a plan—and stick to it.
Footnotes
Keep in mind that the compounding concept in the above examples is hypothetical and for illustrative purposes only. It’s not intended to represent performance of any specific investment, which may fluctuate. No taxes are considered in the calculations; generally, withdrawals are taxable at ordinary rates. You can lose money by investing in securities.
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