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The Power of Compounding | $1,000,000 or a Magic Penny?

The Power of Compounding | $1,000,000 or a Magic Penny?

November 23, 2022

Gift Them Pennies This Holiday Season!

As a young investor, you have a powerful ally on your side: TIME. When you start investing in your twenties or thirties for retirement, you can put it to work for you.

The power of compounding. Many people underestimate it, so it is worth illustrating. Let's take a look using a hypothetical 5% rate of return.

How does it work? A simplified example goes like this: Let's take a look using a hypothetical 5% rate of return on a principal of $100. After a year, you earn 5% interest, or $5. Another year, another 5%, which adds $5.25 this time. In the third year, your 5% interest earned amounts to $5.51, bringing your balance to $115.76. The more money you deposit, the greater the 5% returns. Let's look at another hypothetical example. If you were to start with a $1,000 principal in an account that earns 5% interest per year and contribute $1,000 a year to the account, you would end up with a total of $7,078.20 after five years. That's a total of $1,078.20 earned in compound interest from $6,000 in contributions. That compounding continues, even if you stop making deposits. All you really need to do is let that money stay put.1 

The earlier you start, the greater the compounding potential. If you're investing for retirement in your twenties, you may gain an advantage over someone who waits to invest until his or her thirties.

Even if you start early & then stop, you may be in a better position than those who begin later. What if you contribute $5,000 to a retirement account yearly starting at age 25 and then stop at age 35 – with no new money going into the account for the next 30 years? That is hardly
ideal. Yet, should it happen, you still might come out ahead of someone who begins saving for retirement later.

1. This is a hypothetical example used for illustrative purposes only. It is not representative of any specific investment or combination of investments.

The content is developed from sources believed to be providing accurate information. The information in this material is not intended as tax or legal advice. It may not be used for the purpose of avoiding any federal tax penalties. Please consult legal or tax professionals for specific information regarding your individual situation. This material was developed and produced by FMG Suite to provide information on a topic that may be of interest. FMG Suite is
not affiliated with the named broker-dealer, state- or SEC-registered investment advisory firm. The opinions expressed and material provided are for general information, and should not be considered a solicitation for the purchase or sale of any security. Copyright FMG Suite.

The Power of Compounding, click on the title below for a mind-blowing example:

The Power of Compounding

Planning for retirement should be for more than just the middle-aged; you need to start thinking about it when you first join the workforce or earlier. Whether your company provides a retirement plan or you need to fund your retirement, you must start early. Starting at a young age gives you an advantage and saves you money. The more time you give yourself to invest, the less money you will need to save. What do I mean by this; a person that starts saving early, say $100 a month for the next 45 years, will have time and interest on their side. But, if you start ten years or even 20 years later to save, you will need to save hundreds or even thousands a month to reach a desirable amount come retirement age.

Those of us that are middle-aged, saving for retirement, have a duty to pass on our knowledge. Young adults, children, grandchildren, etc., aren't taught about saving/investing in school. They enter the workforce without the tools needed to prepare for retirement. Income during retirement does not happen magically; it is years of planning, strategizing, and investing.

With the holidays coming, you start to think about gift-giving. However, the receiver may not agree; what better gift than the gift of knowledge? Instead of just giving money to a child, grandchild, niece, nephew, etc., why don't you gift them with knowledge? For example: Give them $50, but ask them to save it for a year; if they still have the money after one year, gift them $60 and ask them to keep saving, and so on. Doing this shows them that saving money can make them more over time. The longer they save, the more they receive. This lesson can then be applied when you introduce them to investing. As parents, grandparents, aunts, uncles, etc., you are responsible for giving them the tools they need to have a secure future. An essential tool is a financial advisor; introduce them to yours.

Share with those you love this blog on compounding; the chart speaks for itself. We need to work together to teach the next generations (children and young adults) how to save, so they can be on the same road to financial security you are.

We look forward to the new introductions and helping the next generations. Contact our office for more information regarding saving/investment accounts for minors; it is never too soon to start.

David S Dixon, CFP®