Money Rules Everyone Should Know – The Miracle of Compounding

by Centsable One on December 29, 2011 · 2 comments

Albert Einstein called the Miracle of Compounding the greatest mathematical discovery of our time and the most powerful force in the universe.  It has also been called the eighth wonder of the world.

And once you take a close look at how compounding works it’s easy to see why.

Fortunately, the miracle of compounding is easy to understand—unlike most of Einstein’s theories–and anyone can do it.  All you need is some spare cash to invest – even a small amount, and time.  Lots of time.

Compounding simply refers to reinvesting the returns of your investments with your original investment as it is earned.  Over time even small amounts of money can add up to large sums.  The problem with compounding – if there is one – is that it’s not glamorous or spectacular.  At least not in the early years.  If you persist however, you will be rewarded with fantastic results.  Turning $2000 into $2200 in year one isn’t going to stop dinner party conversation, but by year 7 or 8 when your investment returns more than you put in each year you’ll have more interest in your investing abilities.

And it’s all done simply by investing a little, often, and leaving the returns to grow.

Let’s look at two working age individuals – Centsable One and Centsable Too.  Neither of them are slouches financially because they know the value of saving and setting a little aside for their retirement during their working years.

Centsable Too, however, is a little more up on the mathematics of finance and knows that starting early will pay huge dividends for her in the future.  With this in mind Centsable Too saves $2000 a year from the time she is 19 until she is 26 investing a total of $16,000 at the long term stock market return rate of 10%.  At 65, Centsable Too will have $1,035,315 saved for retirement.

Meanwhile Centsable One has a little more disposable income in her earlier years, than Centsable Too who started saving early.  At 25, a year before Centsable Too stops investing, Centsable One makes her retirement savings a priority, and like Centsable Too invests $2000 per year.  Waiting 6 years before starting to invest, will cost Centsable One though.

How much is surprising.

Centsable One will need to invest $2000 a year, every year, until she is 55 to match Centsable Too’s savings.  At 65, Centsable One’s savings (assuming a 10% return) will stand at $1,038,197.

CENTSABLE ONE CENTSABLE TOO
Age Investment Interest Value Investment Interest Value
18
19 2,000 200 2,200
20 2,000 420 4,620
21 2,000 662 7,282
22 2,000 928 10,210
23 2,000 1,221 13,431
24 2,000 1,543 16,974
25 2,000 200 2,200 2,000 1,897 20,871
26 2,000 420 4,620 2,000 2,287 25,158
27 2,000 662 7,282 2,516 27,674
28 2,000 928 10,210 2,767 30,441
29 2,000 1,221 13,431 3,044 33,485
30 2,000 1,543 16,974 3,349 36,834
31 2,000 1,897 20,871 3,683 40,517
32 2,000 2,287 25,158 4,052 44,569
33 2,000 2,716 29,874 4,457 49,026
34 2,000 3,187 35,061 4,903 53,929
35 2,000 3,706 40,767 5,393 59,322
36 2,000 4,277 47,044 5,932 65,254
37 2,000 4,904 53,948 6,525 71,779
38 2,000 5,595 61,543 7,178 78,957
39 2,000 6,354 69,897 7,896 86,853
40 2,000 7,190 79,087 8,685 95,538
41 2,000 8,109 89,196 9,554 105,092
42 2,000 9,120 100,316 10,509 115,601
43 2,000 10,232 112,548 11,560 127,161
44 2,000 11,455 126,003 12,716 139,877
45 2,000 12,800 140,803 13,988 153,865
46 2,000 14,280 157,083 15,387 169,252
47 2,000 15,908 174,991 16,925 186,177
48 2,000 17,699 194,690 18,618 204,795
49 2,000 19,669 216,359 20,480 225,275
50 2,000 21,836 240,195 22,528 247,803
51 2,000 24,220 266,415 24,780 272,583
52 2,000 26,842 295,257 27,258 299,841
53 2,000 29,726 326,983 29,984 329,825
54 2,000 32,898 361,881 32,983 362,808
55 2,000 36,388 400,269 36,281 399,089
56 40,027 440,296 39,909 438,998
57 44,030 484,326 43,900 482,898
58 48,433 532,759 48,290 531,188
59 53,276 586,035 53,119 584,307
60 58,604 644,639 58,431 642,738
61 64,464 709,103 64,274 707,012
62 70,910 780,013 70,701 777,713
63 78,001 858,014 77,771 855,484
64 85,801 943,815 85,548 941,032
65 94,382 1,038,197 94,103 1,035,135
62,000 Invested 16,000 Invested

 

BUT Centsable One had to invest $62,000 versus Centsable Too’s $16,000 to achieve the same result (more or less).The six year delay cost Centsable One $46,000!  ($62,000 -$16000).

So, the biggest gift you can give yourself is to start saving early.  The sooner you start saving, the easier time and compounding will make it to achieve your goals.  And if it’s too late for you to board the compound interest money train early, what about your kids?

How much would you need to invest for your children to give them the gift of a $1,000,000 retirement?

Related Posts Plugin for WordPress, Blogger...