In this week’s post, I explain why it's beneficial to start investing as early as possible.
Last week’s post was the first is a series focusing on compound interest. As we discussed last week, compound interest is how, when reinvested, interest or any investment return builds on itself – interest is earned on interest. In order for the power of compound interest to be most magnified, funds need to be invested for as long as possible.
Time is very important for compounding
As mentioned above, compound (reinvested) interest is how interest earned on an investment builds on itself – interest is earned on interest. For example, you start investing with $10,000 and earn 8% each year. In the first year, you earn $800 ($10,000 * 8%). If this return is reinvested, you will earn $864 in the second year ($10,800 * 8%), $933 in the third year ($11,664 * 8%), and $1,008 in the fourth year ($12,597 * 8%). The investment will grow exponentially.
When running a compound interest calculation, there are several different inputs: the rate of return, starting amount, contribution account, frequency of compounding, and number of years invested. All these inputs are important, including the amount of time the funds are invested – the longer funds are invested, the longer interest can build on itself.
For example, at first glance, a 100% overnight return might seem preferable to an 8% yearly return compounded for 10 years. However, an 8% yearly return compounded for 10 years results in a total return of 116%. Of course, having an immediate return offers benefits, including being able to reinvest the windfall for a longer period. Notwithstanding this, the point is that a more modest return compounded for long enough can eventually outpace a onetime, eye-popping return. Investing sooner rather than later can be very beneficial.
I am not trying to suggest that everyone should invest as soon as possible in every circumstance. There are many valid reasons to delay long-term investing, such as: paying off debt, saving to buy a house, investing in education and career development, starting a family and transitioning to a single income. Also, in my opinion, there are certain market conditions that can make investing particularly risky. Every situation is different and competing priorities need to be balanced. Nevertheless, investing early and allowing compounding to work for you can be very advantageous.
Example of the power of investing early
Let’s say you start investing immediately after graduating from college. You save and invest $6,000/year for 10 years from age 22 to age 31. The account earns 7%/year. By the time you reach age 65, the account will have grown to $885,075.
Alternatively, let’s say you wait until age 32 to start saving. You save and invest $6,000/year for the 34 years until you reach age 65. The account earns 7%/year. By the time you reach age 65, the account will have grown to $823,421.
Here are the scenarios compared side by side:
Starting early allows the funds to compound the longest. It’s incredible that the $60,000 of total contributions results in a larger ending account value than the $204,000 of total contributions.
Here is a graph showing these two scenarios:
There are several assumptions included in this comparison that are not perfect. However, the message is clear – starting early allows compounding to work in your favor.
Don’t lose hope
Now you might be reading this and thinking “that’s great, thanks for reminding me that I should have started investing when I was young, but I’m older now and haven’t been saving.” Although this very well might be true, I want to encourage you – you can always start making wiser choices today – not to say that the wiser decision is always investing, as that will depend on your situation. The power of compounding is most amplified over 40 years, but it can also be seen over 20 years, 10 years, or even less.
Financial planning and investing concepts, such as compound interest and investing early, should help you achieve your goals and support yourself and your family. However, putting your hope in anything other than the Gospel of Jesus Christ will leave you disappointed. The Gospel is God’s plan of salvation. We have all sinned and violated God’s law. The just punishment for this sin is death. Instead of leaving us in our sin, God sent his son, Jesus, into the world to die for our sin. Jesus was crucified, died, and was buried. But He rose again on the third day, conquering sin and death. Anyone who believes in Jesus and repents of their sin will not die in their sin, but will have everlasting life.
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.
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