Although I still have to earn money along the way, I continue to rest assured that my financial future is taken care of. Here’s what I did.
It’s About Compound Interest
Once you understand the basics of compound interest, you’ll want to start saving and investing for your future right away. Luckily somebody taught me about compound interest early on in life, so I started saving a significant chunk of my income with my very first job and continued all throughout my 20s.
The principle of compound interest is that the more time your money has to grow, the more exponentially it will do so. Your basic pot of money earns money, and then that money earns money, which in turn earns more money, and so on.
Let’s say you have $10,000 to start with. If you invest it at the age of 20 in a moderately aggressive portfolio earning an average annual return of 8 percent per year, here’s how it will grow:
– 10 years (age 30): $21,589
– 20 years (age 40): $46,610
– 30 years (age 50): $100,627
– 40 years (age 60): $217,245
Using the example above, if you waited to invest that $10,000 until the age of 30, then by the time you were 60 you’d only have $100,000 instead of $217,000. That’s an extra $117,000 worth of growth you would have missed out on in the last 10 years.
As for that 8 percent per year return rate, it’s important to note that this is reflective of what you can earn over the long term (think decades) with a moderately aggressive portfolio of approximately 85 percent equity and 15 percent fixed income investments. For shorter-term financial goals, a less volatile investment combination is recommended — understanding, however, that it won’t compound as dramatically.
For instance, at age 20, $10,000 invested earning 3 percent per year will be worth only $32,620 at age 60. Earning 12 percent per year (an unrealistic return to achieve over the long term), the same $10,000 would grow to $930,510.
Most people don’t have $10,000 to invest at the age of 20. So let’s look at the compounding effects of saving $100 per month, using the same 8 percent annual rate of return:
– 10 years, $12,000 invested (age 30): $17,384
– 20 years, $24,000 invested (age 40): $54,914
– 30 years, $36,000 invested (age 50): $135,940
– 40 years, $48,000 invested (age 60): $310,868
If you wait until age 40 to start saving for retirement, that same $100 per month will only be worth about $55,000 at age 60, which won’t get you far. To reach the same $311,000 as if you had started at age 20, you would need to save $565 per month, totaling $135,600 of your own money (versus just $48,000 of your own money if you started at 20).
So while coming up with that $100 per month in your 20s might feel like a sacrifice, think about the money you’re saving in the long run by starting early.
Rule of 72
The rule of 72 is an easy way to calculate compound interest on the fly.
Simply put, take a rate of compound interest, and divide it into the number 72. The result is how many years it will take your money to double.
For example, seven divides into the number 72 a total of 10 times — so at a growth rate of 7 percent a year, your money will double every 10 years. Conversely, a growth rate of 10 percent per year means your money will double every seven years.
Takeaway: Start Now
No matter what your age, the most important financial move you can make is to start saving for your financial future now. The earlier you start, the less money you’ll need to reach your ultimate financial goals.
Click to read more about the life-changing money lesson this author learned from her parents.
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