This article contains some of the most infuriating information you will ever read, unless you’re 21 years old or younger. It may also fascinate you since it presents a delicious paradox - a person who stops saving can accumulate considerably more than a person who saves diligently all the way, for 35 years, to retirement! This article is all about the magic of compound interest.
You’ll probably wish someone had sat you down when you were young and explained this. If that didn’t happen, don’t despair. You might know a young person to whom you can give the gift of opportunity – the opportunity to make use of the time they have on their side.
Imagine you are 21 again. You have saved $5,000 and you decide, because someone explained this magic to you, that you will save it and add just $1,000 a year till you are 30 years old. Then you leave your nest egg alone until you are 65. For the sake of this exercise, let’s assume that you earn 8% per annum on your savings and there' s no inflation.
Now imagine an alternative scenario. Again, you are 21 years old but you decide there’s plenty of time and you postpone saving till you are 31. At that time, you set aside $5,000 and add $1,000 every single year, diligently and steadfastly, until you are 65. You save for 35 years hoping your strategy will make up for lost time.
Which is the better strategy?
The 10 year strategy where you will have invested $14,000 ($5,000 initially then $1,000 per year in each of the next 9 years) will grow to $332,413. The 35 year plan where $39,000 is invested will grow to only $227,077.
Here’s the chart so you can check the figures (given 8% real return per annum).
21 years old 5,000
22 years old 6,400
23 years old 7,912
24 years old 9,545
25 years old 11,309
26 years old 13,213
27 years old 15,270
28 years old 17,492
29 years old 19,891
30 years old 22,483
31 years old 24,281 5,000
32 years old 26,224 6,400
33 years old 28,322 7,912
34 years old 30,587 9,545
35 years old 33,034 11,309
36 years old 35,677 13,213
37 years old 38,531 15,270
38 years old 41,614 17,492
39 years old 44,943 19,891
40 years old 48,538 22,483
41 years old 52,421 25,281
42 years old 56,615 28,304
43 years old 61,144 31,568
44 years old 66,036 35,093
45 years old 71,319 38,901
46 years old 77,024 43,013
47 years old 83,185 47,454
48 years old 89,841 52,250
49 years old 97,028 57,430
50 years old 104,790 63,025
51 years old 113,174 69,067
52 years old 122,227 75,592
53 years old 132,006 82,639
54 years old 142,566 90,251
55 years old 153,971 98,471
56 years old 166,289 107,348
57 years old 179,592 116,936
58 years old 193,960 127,291
59 years old 209,476 138,474
60 years old 226,234 150,552
61 years old 244,333 163,596
62 years old 263,880 177,684
63 years old 284,990 192,899
64 years old 307,790 209,331
65 years old 332,413 227,077
Amazing and frustrating! It’s time that makes the difference and there’s no substitute for it. Significant increases in the amount of savings don’t make up for the lost opportunity.
Discipline is also essential. Every dollar saved needs to stay saved until it’s needed. Less important is return. 8% real return is on the high side by historical standards but the same message applies for any rate of return. Time is the key and with it must go discipline.
The material in this article was provided by BT Funds Management and is used with their kind permission. Investment funds from BT are incorporated into client investment portfolios which are designed and maintained by Capital Financial Planning Ltd.
If you have over NZ$350,000 to invest and want truly impartial advice, contact us to find out how we can put your money to work to fund your important goals.
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