![]() The ending account value in this scenario drops from over $1.1 million down to just over $385,000. If for example, we assume someone doesn’t start saving their coffee budget (or something of an equivalent amount) until age 35, the numbers look quite different. The reason the miracle of compound interest is so prolific in our example is due to the rather long time horizon (52 years). By the time our investor turns 70, over 90% of the annual return in the account is coming from reinvested capital versus less than 10% from the deposited capital base. But after 18 years of consistent savings and reinvestment, the reinvested return outweighs (greater than 50%) the returns being generated on the deposited capital. At the onset, obviously the money being deposited into the account is doing the heavy lifting and accounts for the vast majority of the total returns being generated inside the account. The chart below shows the percentage of each year’s return that is coming from the reinvested returns versus the invested capital base. The following year, their invested capital base of roughly $81k will only earn them around $6,500, but their re-invested returns of $550k will earn them an additional $44,000 for a total account level return of just over $50,000. By age 63 our investor has deposited a grand total of $81,764 into their account which has generated an additional return of just over $550k. The power of compound interest comes from generating returns on reinvested returns. The hockey stick like growth of the account in the latter years is the visual representation of the 8thwonder at work. For example, 50% of the total $1,011,180 return on investment (money earned above what has been deposited) at age 70 was earned in the last seven years from age 63 – 70. From the chart above we see that the miracle portion of the compound interest effect really comes into play toward the end of the plotted time horizon. We use the coffee example as a simple illustration of how saving at an early age can make a huge difference in retirement. ![]() If instead of spending this amount it were saved in an IRA account where it could grow tax free at an assumed rate of 8% a year starting at age 18, the account would be worth just over $1.1 million by the time our theoretical person turned 70.* Would you believe me? According to the Consumerist, the average American worker spent close to $1,100 a year on coffee back in 2012. What if I were to tell you that by forgoing the purchase of restaurant coffee (including Starbucks and the like) and saving the money starting at age 18, the average American worker could retire at age 70 with over a million dollar nest egg. For some individuals and families this is probably a true statement, but for many of us, it is just an excuse to justify our laziness. Many working Americans feel that they can’t afford to be saving for retirement because they have to worry about their expenses in the here and now. In this week’s Insight we will unpack the miracle of compound interest to hopefully encourage our readers to save early and often. ![]() Unfortunately our education system and spendthrift society do a very poor job emphasizing the importance of saving at a young age in order to harness the full potential of what Albert Einstein considered to be the 8th wonder of the world. And not surprisingly, the younger the worker, the less likely they were to be saving for retirement. ![]() Additionally, of those that were saving, 14% reported they were saving less this year versus last year. We recently came across a study conducted by which concluded that roughly 10% of the US workforce isn’t saving a single penny toward their retirement. “Compound interest is the eighth wonder of the world. ![]()
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