Everyone interested in finance knows this quote by Albert Einstein about the compound interest. I am a firm believer in the magic of compound interest, but there is one persistent myth about compound interest that I want to debunk.
That is that at some (usually quite early) point as you get older, it becomes too late to try and take advantage of the compound interest.
This does not make any sense to me. Whether you are in your 30`s, 40`s or 50`s, don`t lose heart. Start investing and make compound interest work for you.
Let me argue my case further.
Say you are 30 years old and you have not invested a penny. I have heard too many times that for compound interest, you are already a lost cause.
Let`s compare a fewscenarios.
In first, you start investing into stocks as soon as you turn 18 and get a stable job. Despite money being tight during college years and minimum wage jobs, you manage to save $200 every month for 12 years until you turn 30. Let`s say, the market returns on average 8% per year over that period.
You would now have saved $47496.
You now kick your investinginto higher gear and start saving $500 per month. At 60 years of age with 8% market returns, you have accumulated $1,186,743. A quite hefty sum. If you would hold it in stocks yielding 3% dividends per annum, that would be an income of $35,602 per year.
Now, let`s take another scenario. At 30 years of age, you realize that you do not have anything saved for retirement. You listen to financial podcasts that tell you that you`re pretty much a lost cause, you should`ve started saving from birth to utilize the magic of compound interest.But instead of getting mad, you decide to get even, to fight back.
The money you spent on your youth to go to bars and socialize instead of investing allowed you to find your wife and get married. Because of this, you can save $100 on your rent that the single guy in scenario 1 has to pay out of his pocket. You also networked and found a job that pays you $100 per month better than the guy in scenario 1. So you have an edge of $200 per month over the guy in scenario 1, and start saving and investing $700 per month.
You decide to skip vacation trip and drive your old car for one more year, and put the $5000 you save as a nest egg for your investments. You then start saving for the same 30 year period.
At 60 year mark, with the same 8% market returns, you have accumuated $1,042,643. Ok, so you`re not quite matched with scenario 1, but this would still yield you $31,279 yearly return at %3 dividend.
Let`s say you`re again broke at 30. You really get into frugal living, work hard to further yourself in life, downgrade your car, move into a smaller apartment, . Doing this youput down a nest egg of $15,000 and start saving and investing$800 per month.
At 60 years, 8% return, you would stand at $1,285,030. If you could manage a nest egg of $20,000, you would stand at $1,335,344.
This time, let`s say you make it big in your career. You do not save any nest egg but are able to invest $1000 every month for 30 years. At the end your net worth would be $1,417,613. You handily beat everyone in scenarios 1-3.
What we learn from these scenarios is that although it matters quite a lot how much you have saved in the first 10 years, it is nothing that could not be overtaken. Even earningan average income, a moderateinheritance or a year or two of very frugal living driving old cars and not going on holidaysand BAMyour`re back in the game
Of course no scenario caneverbeat the scenario where you would be just as frugal, just as hard working AND also have the 10 years of investment nest egg already accumulated (which would by the way yield $1,612,027 if investing $800/month or $1,895,549 if investing $1000/month).
But really, ignore that, don`t let it get to you. No one fits into just one of these scenarios perfectly. Quite probably, yourability to savewill vary over your lifetime.
Two things will always be the wise thing to do:
- investing (instead of spending) any unexpected lump sums like inheritance, bonuses, overtime pay etc.
- trying to grow the sum you can invest per month, either by living frugally or by increasing your salary (or ideally, both)
Keeping this in mind WILLallowyou to get into the game of compound interest at any point in your life. Don`t let anyone tell you otherwise.