The benefits of compound interest.
Retirement may be 30 or 40 years away, but it is crucial to plan for it at an early age. The reason for this is your ability to capture the benefit of compounding returns . Essentially, if you start saving for retirement with an investment today, the gain that you earn on that initial investment continues to earn additional gains over the span of your investment period. The compounding effect can be truly eye-opening. Here is an example of how a $5,000 investment would grow over time according to a few different average annual return and time period assumptions:
As you can see, if your $5,000 investment today earned 8% a year over 40 years, your ending balance would be over $100,000. This is the beauty of compounding at work over a long time period. Starting early and letting your savings grow via compounded returns is arguably the most important step you can take in preparing for your future retirement. Below is an additional example that compares the results of a 25 year old who begins saving today, contributing $2,000 per year for 10 years, against the results of a 25 year old who doesn't start saving until 10 years down the road and contributes $2,000 per year for 30 years until retiring (again assuming an annual return of 8% per year): *note: years between 19 and 32 were hidden to shorten the table
While the total contributions in example A total $20,000 and the total contributions in example B total $60,000, the individual in example A still ends up with a larger ending value by about $70,000 (almost 30% more in savings). Furthermore, the table below shows how consistent, increasing contributions over your career can make a huge impact. This third example begins with annual contributions of $2,000 that increase by $1,000 (an increase in monthly contributions of only $83) every 5 years until plateauing at $7,000 per year. *again, years between 19 and 32 were hidden to shorten the table
While there are many assumptions inherent to these examples that may differ from real life (actual annual return, distribution of contributions throughout the year, distribution of positive and negative returns throughout the time period, etc.), the main message should be clear: saving and investing for retirement early should put you in a much better financial position down the road.