With costs rising and people living longer than ever before, it’s important to save for retirement even when it’s decades away. If you start early and contribute often, saving can be a relatively simple process.
That’s the experience of a 24-year-old in r/personalfinance who is off to a great start with $37,000 saved in retirement accounts. The young saver said in post that they were “shocked to see” that if they saved $100,000 by age 30, their money could grow to $1 million by age 65 without them having to add another penny, assuming a 7% return adjusted for inflation.
This user is in a position many savers are not in: They’re living at home after graduating, which means that they were able to focus on paying off all their debt over the last year, and are pouring money into their retirement accounts. But the user’s question about saving — “If I’m young is it really that easy?” — is one many people may be asking, and one that can be answered by looking at the power of compound interest.
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Expert advice: Save early and often, as compounding is key to financial growth
Saving for long-term goals like retirement may not be easy, but it can be simple if you create a strategic plan and stick to it. That’s in part due to compound interest, which is the interest that you earn on interest. If you get in the habit of putting money away early, you are not only giving yourself more time to save, but also your money more time to compound.
Michael Gruidel, a certified financial, outlines the value of compounding and why it’s one of the key pillars of financial freedom in a blog post for the Equity Planning website.
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“When it comes to building wealth, few financial principles are as powerful as compound interest,” Gruidel wrote. “The impact may seem small at first, but imagine a snowball rolling down a hill, the longer it rolls the more and more snow it picks up every rotation. Over time, this snowball effect leads to significant growth.”
Here’s an example from Gruidel: “Suppose you invest $10,000 in an account that earns 5% annual interest, compounded annually. At the end of the first year, you’ll earn $500 in interest, bringing your total to $10,500. In the second year, you’ll earn interest not just on your original $10,000 but also on the $500 you gained in the first year. In year two you’ll be earning 5% on $10,500 gaining you $525 and bringing your total to $11,025.”
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If you consider how much an investment like that one can compound over 40 years if someone starts saving in their 20s and retires in their 60s, you can see how saving early significantly helps take advantage of compound interest.
However, calculations assume that the same growth rate holds over time. Unfortunately, the stock market may not always produce an annualized 7% inflation-adjusted return, like the figure the Reddit user included in their estimations. The stock market may crash as you are saving money, and you may need several years to recover from the downturn. That’s why it’s important to not only rely on compound interest, but also implement smart investing strategies, such as diversifying your portfolio and rebalancing so your asset allocation stays aligned with your goals, risk tolerance and time horizon.
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