Why You Should Start Investing Today: The Power of Compound Interest
May 18, 2018
Do you know that feeling when you leave money in your jacket pocket, only to find it years later? The excitement and euphoria you experience because now you’re $10 richer than you thought? That’s exactly what compound interest is like. Unlike that crumpled tener in your pocket though, the phenomenon of compound interest can be lived over and over again.
The “Live Now, Save Later” Attitude
Truth is, too many people plan on “living now and saving later”. The idea of investing is some vague, far off concept that only applies to bankers or old people with a lot of money.
I used to work in the mail room for a company that had a 401k program that matched contributions up to 5%. Most of my coworkers didn’t take advantage of this. Not only could they get out of paying taxes on 5% of their paycheck, but their company was offering them FREE MONEY if they just stashed it somewhere safe. FREE MONEY. But shockingly, there were few takers.
It sounds crazy like that, but it’s a lot more common than you might think. When you’re making less money and budgets are tight, taking 5% of your paychecks and putting it away can seem pretty hard to do. Heck, even if you do have money to spare, who wants to invest in a 401k in their 20s? Retirement is decades away! Spend your money on living now and wait until you’re older to start thinking about saving, right?
Wrong. That’s the opposite of an ideal approach, thanks to one simple yet powerful concept: compound interest.
Compound Interest: Your Best Friend… Provided You Let it Be
Compound Interest: Defined
Compound interest is a reference to the way that your money starts growing at an exponential rate over time. In simplest terms, compound interest is the growth you experience once you’ve reinvested the compound interest you received on your initial investment.
Compound Interest: Explained
For example, let’s say you put down $10 of your paycheck and invest it evenly across the S&P 500. The S&P 500, over time, generally returns about 10% a year. So, $10 for stock today and you’ll hypothetically be looking at $11 worth of stock next year. What if you then leave it in there for another year? Another $1 gain and you’re looking at $12, right? Wrong. The 10% gain that next year is on the now $11 worth of stock, so you’re actually picking up $1.10. The following year, it’s 10% on $12.10, meaning you’re making $1.21. Keep at it, year after year, and you start to see that initial $10 grow exponentially.
Obviously, stocks aren’t nearly that consistent. Some years they’ll grow way more and others they’ll actually lose value, but over the long run, the end results remain the same. The lowest the index has ever returned over a 25-year period, ups and downs included, is 9.28%.
Try using a compound interest calculator to see things in action. As an example, if you put in $10 for 30 years, your investment will grow to nearly $175, which is more than 17x the money you put in initially!
The Greater the Investment, The Higher the Compounding
Now imagine our previous example, but with higher sums of money. Now you’re 25 and manage to scrape together $1,000 a year over the next ten years. That’s just $83.33 a month, which is less than your cable bill in most cases. You then spend the back half of your 30s, and all of your 40s and 50s living dangerously and spending every penny you make. With a 10% return and retirement at age 65, you’ll be looking at $323,346.67. Boom.
The Misfortune of the “Live Now, Save Later” Lifestyle
Let’s compare that previous example with someone who lives it up while they’re young and then gets serious at age 55. Let’s say they contribute $5,000 a year from there on out. By the time they’re 65, they’ve earned just shy of $180,000. This turns out to be about half of the earnings, despite making 5x the contribution than in the previous example!
As another example, what would happen if you invested $10,000 with a 10% return, without making any other contributions the rest of your life? You’re looking at over $450,000 in 40 years! That’s about 40% more than the person making regular contributions starting from 30 years old and nearly 3x what the person starting at 55 years old trying to make up for lost time is looking at.
How To Get Started Investing with Little Money
If you can’t squeeze a regular contribution out of your paycheck, consider putting that windfall away as it comes. Stumble into an inheritance, or get a much bigger check than you’re expecting after filing your tax returns? Even in set-it-and-forget-it mode, you’re much better off taking the plunge now than you would be trying to compensate later in life.
The main takeaway here is the idea that making room to invest later in life is sort of like trying to swim upstream. If anything, you’re much better off setting a smaller sum away now than pumping large sums in later in life when it seems easier.
By investing some money early on, you can help set yourself up for a successful future. Is that as much fun blowing that $10,000 on an expensive trip to Europe or extra rent on your overpriced Brooklyn loft? Absolutely not, at least not in the short-term. The satisfaction comes when you hit your 40s, 50s, and beyond to discover that you can afford to buy the perfect home you’ve always envisioned, send your kids to the college of their dreams, and retire comfortably and sooner than you ever imagined.
Bottom line: the power of compound interest is too valuable to pass up on. No matter what amount you have to spare, investing now is the first step to building a better future for tomorrow.