By Kevin Theissen
As a young investor, you have a powerful ally on your side: time. When you start investing in your 20s or 30s for retirement, you can put it to work for you.
Many people underestimate the power of compounding, so it is worth illustrating. How does it work? A simplified example goes like this: Let’s take a look using a hypothetical 5% rate of return on a principal of $100. After a year, you earn 5% interest, or $5. Another year, another 5%, which adds $5.25 this time. In the third year, your 5% interest earned amounts to $5.51, bringing your balance to $115.76. The more money you deposit, the greater that 5% returns. Let’s look at another hypothetical example. If you were to start with a $1,000 principal in an account that earns 5% interest per year, and contribute $1,000 a year to the account, you would end up with a total of $7,078.20 after five years. That’s a total of $1,078.20 earned in com- pound interest from $6,000 in contributions. That com- pounding continues, even if you stop making deposits. All you really need to do is let that money stay put.
The earlier you start, the greater the compounding potential. If you’re investing for retirement in your 20s, you may gain an advantage over someone who waits to invest until his or her 30s.
Even if you start early and then stop, you may be in a better position than those who begin later. What if you contribute $5,000 to a retirement account yearly starting at age 25 and then stop at age 35 – with no new money going into the account for the next 30 years. That is hardly ideal. Yet, should it happen, you still might come out ahead of someone who begins saving for retirement later.