Compound growth is a powerful investment strategy – a magic trick that allows you to make money from your own money. Sounds too simple, right? Let’s break it down into 3 steps:
1. You put your money in an investment
2. The investment delivers a return, which you then reinvest
3. Over time, the continuous reinvestment of these returns produces even greater returns
And there you have it – compound growth. Told you it was simple.
The surprising tale of three investors
Still skeptical? Here’s a story of three fictional investors, each of whom invested an identical amount of money over the course of 20 years. To make it easy, let’s assume all three earned the same annual return of 3.5% each year until the age of 65.
The only difference is the year they started to save. The results will surprise you, guaranteed.
Anna saved $3,000 per year – or $250 per month – from age 25 to 35.
She then stopped contributing, but the money in her investment account continued to earn a 3.5% return,
which was continually reinvested until she retired at age 65.
Yindi didn’t embark on her investment journey until she turned 35.
She needed to pay off her student debt first, which is important.
At age 35, she started to put away the same amount of money as Anna – $3,000 per year – until the age of 45.
Yindi also left the money invested, where it earned a 3.5% return each year and continued to grow until she also retired at age 65.
Luis was late to the party and wasn’t able to start saving until he was 45.
Like Anna and Yindi, he invested $3,000 per year for a decade, stopping when he reached age 55.
Like the two women, Luis left his money to accrue at a rate of 3.5% until he too turned 65 and retired.
All three investors managed to put away the same amount – $30,000 – over a period of 10 years.
So, their ending balances at retirement should be comparable, right? Wrong. In fact, they were drastically different.
As you can see, Anna ended up with double the amount in Luis’ account!
What explains this huge difference? TIME.
It’s simply the power of compound growth. All three investors earned the same annual market return of 3.5% over the course of their investing lives. However, Anna took advantage of compound growth’s most impactful feature: TIME.
Even though Anna stopped saving at age 35 – investing nothing more for 30 years – her money kept on growing for decades. Due to their later starts, Yindi and Luis’s success had to rely more on their annual savings of $3,000, rather than compound growth.
See? The most powerful tool in an investor’s toolbox is time.
(Saying that phrase three times fast is far more difficult than the concept of compound growth.)
The moral of the story?
While it’s not always easy to find money to put away at the beginning of your career, even a tiny amount can get you started – and helps a lot in the long run. The earlier you can start, the more significant your long-term results will be, but it’s never too late to start either... because every little bit counts in retirement.
Compound growth is the fairy godmother of investing – turning pumpkins into chariots and small contributions into your retirement income. It’s how you can make retirement dreams come true. Bippity Boppity Boo.