Consistency Is Key For Compounding

In this week’s post, I explain how consistency is key for compounding.

In our most recent post, we looked at how it’s beneficial to start investing as early as possible. We looked at an example comparing getting an early start and a late start – and how an early start can be very advantageous. However, consistently saving and investing is preferable to just investing in any one time period. This may seem obvious, but I believe it is still important to emphasize.

Most people can control the amount they save

As we have discussed, compound interest is how, when reinvested, interest on any investment return builds on itself – interest is earned on interest.

As mentioned in our most recent post, when running a compound interest calculation, there are several different inputs: the rate of return, starting amount, contribution amount, frequency of compounding, and number of years invested. We previously emphasized the importance of the length of time the funds are invested, because the longer funds are invested, the longer interest can build on itself. Another input that investors have control over is the contribution amount – the amount contributed to the account each month.

With some limitations, most people have the ability to either cut their expenses or increase their income in order to save and invest more each month. In this way, most people have more control over the contribution amount than most of the other inputs. For example, most people have little control over their “starting amount” – it’s hard to control whether or not you start with a large sum, perhaps from an inheritance or other windfall. But you can control how much you save each month.

In a future post or series of posts, I hope to explore specific strategies that can be used to increase monthly savings.

Example of the power of consistently saving and investing

As usual, it’s helpful to look at some numbers. Below is a chart of the ending values of accounts with different yearly contributions. These accounts are invested for 40 years with a 7% yearly return:

It is crazy to see that saving only $6,000 a year results in an ending account value of $1,281,657 – it's a great example of compounding at work.

The higher yearly savings amounts listed might seem pretty high – who is savings $24,000 a year? However, I would like to point out that although $24,000 might seem like a lot and it is, it represents 15% of a $160k income – which would not be too usual for a mid-career professional or working couple. It’s impressive that $24,000 of yearly savings results in over $5 million.

Here is a graph showing these examples:

If you have any comments, questions, or ideas for future posts, please let me know

I hope you found this post helpful and educational. If you have any comments, questions, or ideas for future posts, please let me know. You can reach me directly via email at crawford@ulmerfinancial.com.