To borrow a line from Star Wars, “Use the force Luke.” The force I’m speaking of is compound interest. Since our main objective is to find an ideal age to begin saving, you have to understand the difference between simple and compound interest. Simple interest can be figured by taking an initial investment that earns interest annually for a period of (let’s say) two years. After the first year you have your original investment plus the interest. In the second year you have the initial investment plus the interest for the second year, the interest from the first year is not added. What you’re lacking is that you don’t earn interest on the interest you already earned. It’s not compounded. Can you see where I’m going with this? With compound interest you take that initial investment and earn interest in the first year, then in the second year you add the initial investment plus the interest from the first year and earn interest on the whole amount.
Now that you know the difference, let’s see how two people use the force!
Person A starts saving at the age of 25. They start out with a zero balance and contribute $200 monthly until retirement (65). Assuming an average annual rate of return of 12%, Person A can retire with $2,061,941.74. Wow! Millionaire status achieved, two-fold.
Person B starts saving at the age of 40. Because person B is further in life, we’ll assume this person started with an initial investment of $10,000 and contributes twice as much, $400 per month, with the same 12% average annual rate of return. Person B will retire at the same age (65) with $886,803.53. Hey, that’s not fair! No, that’s compound interest at it’s finest. J
So, what are you waiting for? Put your pizza and cheeseburger money to better use and start saving! Your love handles will thank you for it!
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