Albert Einstein, in addition to his groundbreaking scientific contributions, has been credited with offering some pretty sound financial advice. He is often quoted as saying, “Compound interest is the eighth wonder of the world. He who understands it, earns it. He who doesn’t, pays it.”
Whether or not Einstein ever actually said this, the quote is a good mantra for all investors – and particularly those who are younger – to adopt.
Harnessing the power of compound interest can help secure financial futures, fund comfortable and/or early retirements, and reduce money-related stress throughout a lifetime. The key to tapping into that potential is to start investing as much as possible as early in life as possible. To illustrate, let’s look at a simplified hypothetical example of two investors we’ll call Jayne and Greg.
Jayne and Greg
Our first investor, Jayne, begins saving at age 25. She invests a monthly amount that totals $3,000 per year until she retires at age 65. Her investments earn a 5-percent return, compounded annually. When Jayne retires, she has invested a total of $120,000 over her lifetime, but the value of her portfolio has grown to $362,399.
Our second investor, Greg, begins saving at age 35. Greg invests a monthly amount that totals $4,000 each year – $1,000 more per year than Jayne. Greg’s investments also earn a 5-percent return, compounded annually. When Greg retires 30 years later at age 65, he has invested a total of $120,000 over his lifetime and his portfolio is worth $265,755. Even though Greg invested the same amount of money as Jayne, his portfolio is almost $100,000 less.
Jayne’s portfolio benefited substantially from the additional 10 years of growth. Her early returns started earning returns of their own. As time passed, the compounding returns continually contributed to the rising worth of her portfolio. Whereas Greg waited to begin investing until he felt he could afford it, Jayne stretched her budget in the early years to make saving for her future a priority – and was rewarded for it.
Learn more with help from the SEC
The U.S. Securities and Exchange Commission’s website, investor.gov, provides a variety of free tools to help investors plan for their financial futures. Those resources include the compound interest calculator used to compute the Jayne and Greg examples, a savings goal calculator and links to tools to help estimate how much to save for retirement and how much to expect from Social Security.
Making an effort to invest early helps younger earners develop focus and discipline around saving and spending habits that benefit them over a lifetime.
It’s a choice that would make Einstein proud.
Budgeting is an important factor at any stage of life. Discover more about AAA’s financial services and speak to an agent today.