Compound Interest: Making Those Numbers Count
If there’s a lesson we seem to learn the hard way every holiday season, it’s the insidious effect of compound calories. A taste here, a nibble there … hey, somebody’s got to lick that bowl. The next thing you know, those numbers have taken on an exponential life of their own, and you’re going to have to put your Fitbit into overdrive to get back on track.
Fortunately, compounding has its advantages too, especially for young investors with decades of time on their side. You’ve probably already heard about how compound interest works, but it never hurts to review what we’re talking about, and to remind ourselves what a big difference those seemingly small numbers can make.
This Business Insider article offers a handy reference, including three charts to bring the message home: “Compound interest occurs when the interest that accrues to an amount of money in turn accrues interest itself.”
This is a simple but powerful notion indeed. When you apply the interest or investment returns you’ve already earned to the task of earning more of the same, that’s about as close to a free lunch as you can expect along the road to riches.
To put this idea into context, one of the charts explores how much you would need to save monthly to be a millionaire by age 65 (assuming a 6 percent return, with all earnings left to compound over time).
- At age 20 – If you let compound interest work in your favor from the get-go, you can be on track to achieve that $1 million nest egg by saving just over $361/month.
- At age 35 – If you wait a decade before getting started, you’ll need to sock away nearly $1,000/month to make up for lost time.
- At age 55 – As your timeframe shortens, so does the ability to benefit from compounding. By age 55, your monthly savings would need to be more than $6,000/month to achieve the same goal.
How To Do It
Clearly, the math is on your side as a young investor. Then again, as we recently covered in Sheri’s Advice to Her Niece, life is rarely as neat and tidy as the math allows for, especially for young adults juggling multiple new financial responsibilities. Here are a few reminders on how to make the most of your envious ability to compound over the long haul.
Use that raise (or other found money) to save. There may be no better way to save than with money that you were already getting by without. By applying all or part of any raises straight to savings, you won’t have time to miss spending it today. Even with your initial salary, do your best to auto-deposit a portion of it into savings, like a “raise” to yourself. The same applies for similar new sources of income you may receive.
Ask and ye might receive. This Washington Post piece offers ideas and inspiration on negotiating for that raise to begin with. The author observed, “Younger workers were less likely to ask for a raise. But those who did ask were just as likely to receive one as older peers who asked for more money.” She also cited a Nerd Wallet survey finding that about 75 percent of those asking for raises got one, regardless of age.
Even if the extra income is modest, it can make a substantial difference when compounding comes into play. For example, assuming a 3 percent average annual wage increase without negotiations, the Washington Post piece suggests that most companies are prepared to offer more when pressed for it. “A person who negotiates for a 5 percent increase in pay on a $40,000 job offer at 22 can make an extra $170,000 by the time she turns 65 than if she had not negotiated.”
Minimize the tax toll. As we described in an earlier post, one of the best gifts young investors can be given – or can give to themselves – is a Roth IRA. By beginning to save when you are young, and sheltering the proceeds from the higher tax brackets to which you will likely subject by the time you’re 60-something, you are compounding on compound investing in ways that we more seasoned investors can only dream of.
Cash in on the Tooth Fairy. Okay, this one is admittedly tongue in cheek (no pun intended), but according to a 2015 Delta Dental of Illinois analysis, if today’s children were to let compounding do its thing to the Tooth Fairy gifts found under their pillows, they might have a tidy sum with which to ramp up their retirement. Karyn Glogowski of Delta Dental of Illinois noted that saving their Tooth Fairy proceeds “could mean a whopping $14,000 per child when current 6-year-olds in Illinois hit retirement age if the child invests all of his or her Tooth Fairy gifts.”
That’s no chomp change.
Sage Serendipity: There is a marketing phenomenon on YouTube targeted mostly to children called “unboxing”. The New York Times wrote an article the other day trying to explain its puzzling popularity; perhaps it is popular because they are “freeing” the toys? If you watch the number three video on YouTube last week it’s of someone unboxing Disney toys. Target also has a webpage devoted to children opening toys. And it’s not just kids — there are grown men with YouTube channels devoted to this phenomenon, such as Jordan with the YouTube monikor of CaptainSparklez. The Ultimate Google Unboxing is worth watching just to see how far Google went to make him a customized elaborate puzzle box! You can also watch him pop bubble wrap with his feet.