Compounding interest is a very powerful thing. Today we will take a look at an example that will hopefully convince you or your children to start saving early and often.
This story is about two twin brothers Matt and Steve. After graduating high school at age 18, Steve skipped college and worked at a small construction company. For the next ten years he saved $10,000 per year into a retirement account. At 28 years old he realized he did not want to spend his whole life doing back-breaking labor, so he quit and moved to Costa Rica. He managed to find a job to cover his living expenses, but never saved another dime.
Unlike Steve, Matt had attended college. After graduating, he worked very hard but did not make much money at first. As he watched his brother fly off into the jungle, he landed the job of his dreams. He finally got the chance to start funding his retirement account and saved $10,000 at the end of every year from age 28 until he retired at the age of 65.
As you can see from the chart below, Matt saved significantly more than Steve:
So who do you think had more money at age 65? The answer may surprise you. Let’s say that both brothers invested their money in similar investments and received 8% per year. At the time Steve stopped saving at age 28 their accounts looked like this:
Steve comes home from Costa Rica and finds himself a millionaire. He also has more money than his hard-working brother. To make up from his slow start, Matt would have to save $12,303 every year to match his brother’s account. That would be a total savings of over $450,000 – much more than Steve’s total savings of $100,000.
Hopefully this example helps you realize the power of compounding interest. Every dollar saved today is much more valuable than the dollar saved next year or the year after. It is never too late to start saving – the longer you wait, the harder it will be to reach your financial goals. In the example above if Matt waited until age 45 to start saving, he would have to save $54,593 each year to match Steve’s account!
Save early and save often.