Saving, Investing and the Power of Compounding Interest
“Two Roads Diverged in a Yellow Wood…” Robert Frost
As we move on in years, many of us often reminisce about a particular decision that led us to pursue a career, find a spouse or significant other, settle down in a certain location, or begin investing for retirement. Normally, young adults possess significant ardor to pursue educational goals, career development, meaningful and lasting relationships, but often falter when it comes to investing for retirement.
There has been a slow-moving, tectonic shift over the past several decades from employer-funded pensions (defined benefit plans) to employee-funded retirement accounts (defined contribution plans). Considering that the average American worker/investor is woefully unprepared for retirement (A 2019 Government Accountability Office study found that nearly 48% of Americans aged 55 and older don’t have any retirement nest egg or a traditional pension plan!)1 Perhaps it’s time to traverse down a different path.
What if high schoolers (or even elementary schoolers) were taught the awesome power of compounding interest in a required “personal finance” class. It’s hard to imagine that such a class would not be as critical to most students as algebra, calculus, and physics. Taking this a little further, let’s examine what would happen if a young adult, upon turning 19, had saved $12,000.00, from working odd jobs, or was gainfully employed after graduating from high school. What would be the result of investing the maximum annual contribution into a Roth IRA (earned income contribution limits of $6,000 per year, or $7000 for investors age 50 and older) for two years, if the principal and or earnings where left untouched? Then, that investment was set aside and “left to marinate” until that 19-year-old turned 70?
Well, here is where that high school calculus class comes in handy… The compounding interest formula is as follows: A=P(1+(r/n) ^nt (easy right!) Thankfully you can access a compounding interest calculator, like the one utilized below, plug in the data and voila’ you’ll get your answer.
Illustration I
Initial Investment:$12,0000.00, annual interest rate, compounded annually = 8% (a reasonable rate of return given the fact that historically the S&P 500, average annual return from 1926 – 2018 is about 10 – 11%) 2
The attached compounding interest chart demonstrates the results: (https://www.investor.gov/financial-tools-calculators/calculators/compound-interest-calculator) Investor gov, US Securities and Exchange Commission
Results:
Scenario #1. 7 % Return = $404,704
Scenario #2. 8% Return = $656,472
Scenario #3. 9% Return = $1,060,130
Illustration II
What if the young, enterprising 19-year-old invested $200.00 per month into the Roth IRA account for those 52 investment years….
Results:
Scenario #1. 7% Return= $1,526,726
Scenario #2. 8% Return = $2,267, 653
Scenario #3. 9% Return = $3,389,307
Compounding Interest, Chart II
OK, so perhaps at this point you’re asking, “what exactly is compounding interest? “Compound interest is when the interest you earn on a balance in a savings or investing account is reinvested, earning you more interest. As a wise man once said, “Money makes money. And the money that money makes, makes money.” 3
Hopefully these examples have piqued an interest in the “Power of Compounding Interest.” A phenomenon that apparently led to a quote attributed to Albert Einstein, who responded to a question by stating that, “Compounding interest is the eighth wonder of the world.”
*Unfortunately, we cannot return to a “younger version of ourselves,” to divert some of our personal, fleeting expenditures toward investing but there is something that can be done.
Call to Action: Start saving and investing now and encourage the young investors in your life to save, invest and reap the rewards of compounding interest. Better yet, establish a brokerage account for a young adult, “sprinkle it” with some seed money and let them see for themselves the value of saving and investing!
Sources:
- Retirement Security: Most Households Approaching Retirement have Low Savings, an Update. www.gao.gov, GAO-19-442R#sumary, Accessed March 5, 2021, U.S. Government Accountability Office.
- What is the Average Annual Return for the S&P 500, Investopedia.com, by JB Maverick, June 1, 2021.
- Life-Changing Magic of Compounding Interest, Kate Ashford, Benjamin Curry, November 24, 2020, The Forbes Advisor, www,forbes.com
- Attached compounding interest calculator/charts downloaded from www.investor.gov
The content is developed from sources believed to be providing accurate information. The information in this material is not intended as tax or legal advice. It may not be used for the purpose of avoiding any federal tax penalties. Please consult legal or tax professionals for specific information regarding your individual situation. This material was developed and produced by FMG Suite to provide information on a topic that may be of interest. FMG Suite is not affiliated with the named broker-dealer, state- or SEC-registered investment advisory firm. The opinions expressed and material provided are for general information, and should not be considered a solicitation for the purchase or sale of any security. Copyright 2021 FMG Suite.
Thomas Commander is a Registered Representative offering securities and advisory services through United Planners Financial Services. Member: FINRA, SIPC, CA Insurance License No. 4035449
*If you're interested in discussing compounding interest or to develop a plan for your financial future please feel free to contact me:
Contact Info:
Email: tom@jacobsonwealth.com
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