Oh the Joys of Compounding!

In its February issue, Kiplinger's lists a "KipTip" that details what they call the magic of compounding. The details:

• If you start at age 22, save $100 a month and earn an 8% return until you're 65, you'll have $450,478.

• If you start at age 32, save $100 a month and earn an 8% return until you're 65, you'll have $194,654.

Ah, yes. It's a beautiful thing, isn't it? ;-)

As you're probably aware, the biggest impact from compounding happens in the latter years -- as your investments which started as a snowball now turn into an avalanche. But the sooner you start that snowball rolling the more time it will have to gather more snow, and the bigger avalanche it will be in the end.

Ok, so maybe the avalanche analogy isn't the best, but you get the idea. Invest early, invest often and let time work its magic. Do this for a long time and you'll become wealthy.

For some related thoughts on this topic, see How to Get Rich in Three Easy Steps.

Comments

[TheJapChap]

FMF (& anybody else with an opinion!),

I love this post on the power of compounding and it makes me question my current financial gameplan--any advice would help:

My wife & I are both 23 and fresh out of college. We just paid off both of our cars and plan to avoid financing vehicles down the road. Between our jobs, we make around 80k. The only debt in our name is roughly 35k in student loans, ranging from 4.5% to 8.5%. We currently rent and want to own a home and start a family by the time we are 30.

I take advantage of a generous 6% match for the first 4% that I put into my 401k and she has a automatic retirement contribution of 7.5% with her employer This is our only systematic retirement savings at this point(ie, no Roth IRA's, index funds, etc.), allocating every other penny towards eliminating the student loan debt.

Our philosophy matches Dave Ramsey's on most, but not all, levels--that is, I'm not skipping a free 6% company match just so I can get rid of my debt. Using his words, "That's just plain stupid!" But I DO want to realize the investing potential of a person who is debt free... We figure we could knock out the student loans in 12 to 18 months if we stay focused and THEN we could start saving for retirement and a house.

Would you continue this assault on debt, and forego hardcore investing until it has been eliminated---or would you balance it out with retirement investing and take advantage of "the joys of compounding"?

Thanks in advance for any advice!

[aaktx]

JapChap,

It sounds like you are on track. You are smart for taking advantage of the employer match. Never turn down free money when it is offered. You are fortunate that you are so young and saving for retirement. It will grow into a monstrous nest egg; hopefully your asset allocations are decent. I would get rid of the debt before you invest additional money into a retail brokerage account and continue to max out you 401K. Hopefully you have the funds and lifestyle to do both. Good luck

[FS]

@ TheJapChap:

Your average savings rate for retirement is nearly 9 percent, which is *great* for just starting out, IMHO. I'd suggest you continue your plan to agressively knock out the debt, then look at your options. (You can't imagine the peace of being debt free!)

About 10 years ago, my wife and I were in the same place as you and yours. We knocked out all debt, then saved an amount equal to 6-months of expenses for an emergency fund, next saved for a down-payment (5%) on a home, and finally my wife quit her full-time job to be a full-time mom when our son was born (when we were 28.)

You can do it!

Our next goal - maybe to give you some additional inspiration - is to have our home paid off by age 40, (while we continue to save 20+% of income for retirement in the interim.)

[Lord]

Using real rates is much more insightful. Who cares if you have a million bucks forty years from now if all it can buy is a hamburger?

[rocketc]

Aaah! I hate posts like this! If only. . .

[seekingfinancialcamelot]

I also shudder every time I read an article like this. I too am aggressively paying off cc debt and at the moment, not contributing to my 401K. My gameplan is to pay off the CC debt then begin to contribute as I pay off house and car debt. I know many would think that is foolish but I cant sleep at night with that debt looming over my head.

Having house and car debt never worried me. But the last two years my CC debt has gone from $0 to $40,000. But still....all that compounding I am missing out on. sheesh

[db]

@seeking:

It's not at all foolish to say you can't sleep at night with debt looming over your head. I've been feeling that way for years.

Still battling the debt (primarily the student loans at this point). Still feel queasy constantly knowing I owe somebody something...but also realized the time is NOW to save money too.

[SameStory]

If I had a nickel for every time a PF blogger put up a post about compound interest I swear I'd be a multimillionaire. This is not news, and its not a fascinating tip - its common knowledge to everyone except perhaps the bottom 10% of the population. Does it need to be repeated over and over, even in the same blog??

[Lily]

SameStory, I'm kind of with you. I don't think it hurts to remind people that they're losing out on much more than X amount of dollars if they spend it instead of investing it. But I hate the rhetoric of "the magic of compounding," as if compounding were a black box where money goes in and more money comes out. It's not magic! There's a concrete, logical reason why the money grows. I pretty much stop reading (PF books, magazine articles, etc.) when the phrase "the magic of compounding" appears.

Of course, you never hear people explain why not paying off debt is bad. No one ever mentions "the magic of compounding" when it's interest owed that's piling up.

[FMF]

SameStory --

You make a lot of assumptions -- and some claims I don't think are true. For instance:

"This is not news."

It's not meant to be news.

"It's not a fascinating tip."

It is to me.

"It's common knowledge to everyone except perhaps the bottom 10% of the population."

Can you back up that stat with any facts? I think not. Obviously, it's an interesting enough point for Kiplinger's to put it in their magazine. And I'd guess that their readers aren't in the bottom 10% of the population.

"Does it need to be repeated over and over."

Much of personl finance is simply doing the basics well. To that end, I cover the basics again and again.

"Even in the same blog??"

You're assuming that 1) everyone has seen it when I've posted before, 2) there are no new readers of this blog since last time I posted on it, and 3) there's no one in the 5,000 or so daily visitors here who might find this new and/or interesting. I think those are all very big (and incorrect) assumptions.

How about lightening up a bit and simply skip a post if you don't like it?

Lily --

"Of course, you never hear people explain why not paying off debt is bad. No one ever mentions "the magic of compounding" when it's interest owed that's piling up."

That's not true. I've mentioned it before in the context that you can have compounding work for you (investing) or against you (debt.) I know others have as well.