How to Retire Rich: Use the Power of Compounding

One of the great principles of money management is the power of compounding -- how over a long period of time your money feeds on itself, earning additional dollars which ultimately grow into a sizable amount. This is the main point in a Yahoo piece discussing retirement. In it, Ben Stein tells us:

In the course of this column, I am going to tell you a lot of actions to take to save your retirement, but the first one I want to tell you is probably the most vital: Start early. The difference between starting early and starting late is stunning.

Now if you've been reading personal finance articles for any reasonable amount of time, you've probably heard the next example (or one like it) about a million times. But I'm going to reprint it anyway because the illustration is so over-powering (and the concept so important) that I think it's worth repeating:

Assume you start working at age 21. Assume that, adjusted for inflation, your real income grows by 100 percent in the course of your life (a very modest assumption). Assume that you invest in a broad portfolio of the stock market, say the Vanguard Total Stock Market Index Fund (VTSMX). Assume you take the very smart advice of my other investment pal guru, Ray Lucia, and keep lots of ready cash in a bucket so you don't have to tamper with your stocks and can keep letting them compound over long periods of time. Also assume you want to retire on 80 percent of your last year's salary before you retire at age 65.

If you start at 25 with six months' salary saved, you need only save 3 percent of your total, pre-tax salary per year to get the nest egg you need (roughly 15 times earnings at retirement) by age 65. But if you start at age 45, you need to save 18 percent of your salary (again, assuming you start out with six months' of salary saved). If you start at age 50, you need to save 28 percent of your salary. And if you start at age 55, you need to save nearly 50 percent of your gross salary to get where you need to be.

Again, he repeats the "money" section of this article:

In other words, if you start with a sensible plan at a young age, you can get to your savings goal without breaking a sweat. If you wait until you are middle aged, it takes some serious doing. If you wait until you are a silver fox, you're required to do some heavy lifting indeed. If you assume the stock market has passed its glory days, you need to save even more.

The point is simple, as most vital points are:

You need to start today, right now, this second, to save in a prudent way.

Let the magic of time and compounding do the heavy lifting.

Great, great advice.

Start today. Invest/save as much as you can. Keep adding to it over a long period of time. If you do these simple things, you'll accumulate a substantial retirement fund.

Comments

[Ed]

Compounding is the only slave that works 24/7!