It sounds harsh when you read articles that tell you to save now or you’re bound to lose out on some arbitrary but massive amount of money. The reality is, putting off a savings plan for any amount of time is harsh. So, why do so many people choose not to save early regardless of caution? Because, for many, the time element of compounding interest is not well understood. Let’s dive into a couple of points that explain compounding interest and how understanding it can help you avoid upending your budget to start saving.
What is the Compounding Interest?
Compounding interest is when you earn interest on top of both the principal (the balance you added) and the interest you earned on that principle. Over enough time, this can result in exponential growth of your savings.
When to Begin – Start Early, Start Small
Whether you are 20 and starting your first job or 30 and starting to wonder about retirement, now is always a good time to start putting money away. However, someone in their 20s will be able to save half as much as someone ten years older than them to get the same result.
- A 20-year-old who saves $100 per month in an investment portfolio with a 6% interest rate, compounding monthly, would have almost $30,000 by the time they were 35 and over $277,000 by the time they were ready to retire.
- On the other hand, a 30-year-old saving the same amount at the same frequency would have a surprisingly different result. By 35, this person would have a mere $7,000. When they are ready to retire, they will have roughly $143,000 saved. To catch up with a 20-year-old’s savings at retirement, they would have to put aside almost $200 per month.
The earlier you start saving, the easier it will be. Don’t wait another ten years; start saving and let time do the work. If you are still unsure when or how to start saving, contact us for more information.