The Powerful Effects of Compound Interest

Compound interest depicts white piggy bank on table.

Presented by Kris Maksimovich, AIF®, CRPC®:

Getting an early start on your retirement savings may end up being the best financial move you can make for yourself and your family. Thanks to the power of compound interest, you have the opportunity to make your money work for you and grow exponentially on a tax-deferred basis.

Think of interest as a fee paid for using borrowed money. The original amount of money in your retirement account (without added interest) is known as the principal. Compound interest is beneficial because it’s calculated based on the principal plus the interest, resulting in greater interest accrual over the life of the investment.

The benefits of saving early and often

Let’s look at the investing choices of two hypothetical investors, Amy and John.

Amy started investing at age 25. She invests $3,600 per year for 15 years at an 8-percent interest rate and then stops.

Amy’s Investments Investment with Compound Interest
At age 40 $104,500
At age 70 $1,050,000

 

John didn’t start investing until he was 40. He invests $3,600 per year for 30 years at an 8-percent interest rate.

John’s Investments Investment with Compound Interest
At age 40 $0
At age 70 $450,000

For illustrative purposes only.  The charts above does not represent the performance of any specific investment.  This example assumes no withdrawals, expenses and tax consequences.

By now you may be muttering, “Okay, I get it. Saving earlier is better than later.” While this is a key point (and one you’ve probably heard before), many people don’t realize just how important it is until they fall into financial trouble. After all, many things can get in the way of retirement saving besides procrastination, such as paying off a mortgage, car loans, sending kids to college, and unexpected injuries or illnesses. The best way to be prepared is to kick off a pattern of saving and take advantage of compound interest as early as you can.

Retirement readiness

Although retirement may be the furthest thing from your mind at this point, recognizing how costly it can be may help you stick to a savings plan. Here’s an overview of some of the expenses that may come into play:

  • Increasing health care/long-term care costs. As you get older, you may have additional medical concerns or require care in a nursing home.
  • Income taxes. When you begin withdrawing funds from retirement accounts, you may lose much more of your financial “nest egg” than you thought possible to income taxes.
  • Everyday expenses. Groceries, home maintenance and insurance, utilities, and other basic living expenses can eventually start to chip away at your savings.
  • Travel and hobbies. Many retirees want to travel and take up new hobbies (after all, this is what retirement should be about). Unfortunately, such dreams may not come to fruition if you haven’t saved enough to cover the more crucial expenses highlighted above.

Ready to start saving big?

Clearly, getting an early start on your retirement savings (and sustaining that habit over time) can greatly improve your future financial stability. To see how much your money could grow, check out the Compound Interest Calculator available on Investor.gov.

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Kris Maksmovich is a financial advisor located at Global Wealth Advisors 18170 Dallas Parkway, Suite 103, Dallas, TX 75287. He offers securities and advisory services as an Investment Adviser Representative of Commonwealth Financial Network®, Member FINRA/SIPC, a Registered Investment Adviser. He can be reached at (972) 931-3818 or at info@gwadvisors.net.

Authored by the Investment Research team at Commonwealth Financial Network.

© 2019 Commonwealth Financial Network®

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