Many people become intimidated when they think about the amount of money they have to save for emergencies, retirement, college and any other long-term, high-cost goals. And while it’s understandable to feel overwhelmed by these goals, it’s important not to get discouraged because through the power of compounding interest, you may find the process easier than you expect.
What is Compounding?
When you save money in a CD, money market or savings account, and even some stocks, you earn interest on what you’ve saved. That interest is added to the account balance and then the next time interest is calculated, it’s based on the increased value of your account. In effect, you earn interest on your interest that you earned in prior months and years. And you keep earning interest on that interest for as long as it remains in the account. Many people understand this concept, however, don’t fully appreciate the impact that compounded earnings can have, especially over a long period of time.
An Example of Compounding
Here is an example of the effect of compounding. If you invested $5000 annually at the end of each year over a period of 30 years, you would have invested a total of $150,000. However, if it grew at 6% annually, because of compounding, after 30 years, you would have over $395,000!
In Compounding—Time Matters
One of the biggest assets you have when you plan to leverage the power of compounding is time. The longer you allow your money to grow and your interest to compound, the more money you’ll earn. But that also means there’s a price to be paid when you wait.
This graphic shows how much impact time has on your investments. This shows three different portfolios- all three invested $3,000 per year until age 66 and all three grew at 6% per year. The only difference was that the blue portfolio started at age 20, and green portfolio waited to age 35, and the purple portfolio started investing at age 45. Yes, the blue portfolio invested by the 20-year-old had more years to put aside money, but they only invested $75,000 more than the person who started at age 45 in purple. Yet, they ended up with almost $560,000 MORE than the purple portfolio by age 66. That is the power of compounding over time.
Luckily, it’s never too late to gain interest and growth through compounding so don’t be discouraged. We are just simply trying to illustrate the importance of acting sooner rather than later. At Kramer Wealth Managers, we want to help you leverage the power of compounding as part of your Wealth Path. Contact us today so we can help you get started.
Content provided by Broadridge Investor Communication Solutions, Inc.
