4Q2018 | Ages 18 – 29
The Most Powerful Force in the Universe
Many people have heard that Albert Einstein referred to compound interest as the most powerful force in the universe. If I were to be so bold, I would suggest that compound interest plus time is the most powerful force. And if you happen to have lots of time, the effects can be staggering when it comes to your retirement.
The Basics
Compound interest is essentially earning interest on interest you have already earned. For example, if you invested $1,000 at the beginning of year 1 at a 10% interest rate, at the end of year 1 you would have earned $100 dollars and now have $1,100. So, at the beginning of year 2, your invested amount would be $1,100, and you would then earn interest during year 2 on the $1,100. You may have heard the term “letting your money work for you” or “work smarter not harder”. Compound interest does exactly that. You are earning interest on money that you “put to work” while you don’t need it, so it is there for you when you do.
Rate. The rate is the percentage return your investment is earning you. In the above example, the rate was 10% or $100. Typically, but never guaranteed, the rate of your return increases the more aggressively you are invested. There are several factors to help you determine the amount of risk you should take and how to create a plan based on an expected rate of return.
Time. Time could be one of the biggest factors to help you determine your risk tolerance and objective for investing, but as we will find out, it is one of the most powerful tools for growing your wealth. The little bit of interest in the example above may not seem like much at first, but the longer your money can work for you, naturally, the bigger it will become. Time is a major factor especially in the latter years when your money really begins to exponentially grow. That is why your financial advisor is so adamant about starting early. Let’s look at some examples below that could change the way you start saving today.
What does this mean for you?
Take the following example comparing interest rates for different time frames.
The value of $1,000 over time
$1000 Invested @ | 4% | 6% | 8% | 10% |
10 years | $1,480 | $1,790 | $2,158 | $2,593 |
20 years | $2,191 | $3,207 | $4,661 | $6,727 |
30 years | $3,243 | $5,743 | $10,062 | $17,449 |
40 years | $4,800 | $10,285 | $21,724 | $45,259 |
Now remember, we are looking at the power of compound interest when we only put $1,000 to work for us. At first glance you might conclude that the funds will grow in proportion to their respective interest rates. But with only a 2% difference in rate, the return is OVER DOUBLE in each scenario after 40 years. Would doubling your investment for retirement be meaningful to you? The power of time and compound interest is a powerful tool to help you do that.
Now let us imagine a scenario where 2 people, invest the same amount of money, for the same amount of time, but one waits until he is 35 to start investing.
Richard and Tommy
Richard & Tommy both start working at 25 years old
Richard starts saving $400 month for 10 years at an average rate of 8% and then stops
Tommy waits for 10 years then starts saving the same amount and at the same rate as Richard
Tommy NEVER catches Richard by the time they retire at 65 regardless of the fact he never stopped investing $400 a month for the next 30 years!
Year | Richard | Tommy | |
1 | $5,006 | $0 | |
2 | $10,412 | $0 | |
3 | $16,250 | $0 | |
4 | $22,556 | $0 | |
5 | $29,366 | $0 | |
6 | $36,720 | $0 | |
7 | $44,664 | $0 | |
8 | $53,242 | $0 | |
9 | $62,507 | $0 | |
10 | $72,513 | $0 | |
11 | $78,314 | $5,006 | |
12 | $84,579 | $10,412 | |
13 | $91,345 | $16,250 | |
14 | $98,653 | $22,556 | |
15 | $106,545 | $29,366 | |
16 | $115,069 | $36,720 | |
17 | $124,275 | $44,664 | |
18 | $134,216 | $53,242 | |
19 | $144,954 | $62,507 | |
20 | $156,550 | $72,513 | |
21 | $169,074 | $83,320 | |
22 | $182,600 | $94,991 | |
23 | $197,208 | $107,596 | |
24 | $212,985 | $121,209 | |
25 | $230,023 | $135,911 | |
26 | $248,425 | $151,790 | |
27 | $268,299 | $168,939 | |
28 | $289,763 | $187,459 | |
29 | $312,944 | $207,461 | |
30 | $337,980 | $229,064 | |
31 | $365,018 | $252,395 | |
32 | $394,220 | $277,592 | |
33 | $425,757 | $304,805 | |
34 | $459,818 | $334,195 | |
35 | $496,603 | $365,936 | |
36 | $536,332 | $400,216 | |
37 | $579,238 | $437,239 | |
38 | $625,577 | $477,224 | |
39 | $675,624 | $520,407 | |
40 | $729,673 | $567,045 |
To summarize what just happened in our scenario, look at it this way.
Richard
- Invested $48,000 of his own money over 10 years
- His $48,000 grew to $729,673 at 65 years old
Tommy
- Invested $144,000 of his own money over 30 years
- His $144,000 grew to $567,045 at 65 years old
Tommy invested for 30 years and could never catch Richard, who only invested for 10 years. Had Richard not stopped after 10 years and continued to save for the same 30 years and then stopped, he would have accumulated over $1.2 million dollars when he turned 65. Over double what Tommy saved. The only difference was time. Richard started right away, and the reward was exponential.
When you start thinking about saving for your future. Remember, whatever is keeping you from starting today could be the one thing that has the greatest impact on your retirement. The more time you have, the better off you will be in overcoming the hurdles along your journey. The average American waits until they are in their 50’s to start saving for retirement. Richard had the opportunity to let his money to work smarter when he started contributing at 25 years old and was able to allow his money to grow for a longer period of time. While Tommy started at age 35, imagine the cost had he waited until he was 50, like many people do.
Micah Schmidt
Financial Advisor
[email protected]
This commentary is for informational purposes only and does not constitute investment advice nor reference the appropriateness of any individual investment alternative.
Advisory services offered through Prime Capital Investment Advisors, LLC. (PCIA) a Registered Investment Advisor. Prime Capital Investment Advisors doing business as Qualified Plan Advisors, “QPA.” 6201 College Blvd., 7th Floor, Overland Park, KS 66211.