Waiting too long: Retirement and Compound Interest

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Back when I first started out in my career (1986)  making a whopping $14,000 a year, I was offered my first chance to participate in a retirement account.

“Retirement? I’m 23 years old.. That’s like.. Forever away. I need the money now. I have Student Loans to pay and beer to buy. I’ll pass. I’ll have time later”.

Yes, please kick me. I took a very uneducated view of my financial state. Blame no financial experience, poor/no advice from parents or whatever else is handy. However, it is obviously all on me. So we scratch that up to the idiocy of youth and deal with where we are now (26 years later).

“Time is on my Side”… Jagger/Richards

If you’re reading this at age 23 (or 27, 33, etc), take advantage of what is the best method of increasing your wealth. And the one thing you can’t get back. TIME. Don’t do as I did ignore the goodness of Delayed Gratification. There is a famous Standford University psychological experiment that tempted kids with the choice of one marshmallow immediately, or two marshmallows later. Click here for study details. It doesn’t help me financially that my actions are the object of a psychological study, but it does help me in understanding the behavior.

The idea of Compound interest is very powerful… if you can overcome the Instant Gratification.

Ben Franklin

I’m sure you’ve heard the example of Compound Interest as enacted by Benjamin Franklin. You haven’t?

Here’s a quick summary:

The man who said “A penny saved is a penny earned” knew quite a bit about the math behind the idea of Compound Interest. The formula itself bores me to tears, however, the practical application is pretty darn cool. When Franklin died in 1790, he left around $5000 to the cities of Boston and Philadelphia. His idea was to allow the needy to borrow from this fund at 5% interest. He did have some stipulations:

Both cities were to invest the money, at an interest rate of 5% (compounded yearly) and leave it untouched for 100 years. At the end of the 100 years, the city was allowed to spend three quarters of it on a city improvement project and the rest was to be reinvested for another 100 hundred years at the same interest rate.

After 100 years, his initial investment turned into a little over $650,000! After this time, each city could use 3/4 of the money to loan needy people. That left $164,000 to continue to invest for the next 100 years. After 200 years, Philadelphia had $2,497,000 and Boston had collected $5,533,000. The final results varied due various rates of return on the investments.

Yes, I do understand that not everyone has 200 years to wait for that kind of money. Our investment time line is a tad shorter. However, the idea of Compound Interest still makes sense. See the table below for a example. Assuming an Annual contribution of $2000 starting at the age of 22 and an annual earned interest at 7%, a person would have $495,553 by the time they reach 65 years of age.

Of course, the returns will vary over time, and I’ll leave it to your imagination (or math) to see how well you could do if you increased your annual contribution. (Spoiler alert. With the same assumption, an annual contribution of $4,036 will get you a million dollars by age 65). To work through some examples on your own, please review the Compound Interest spreadsheet on  the Financial Resources Page

A mere $2,000 a year would have netted us a little under a half a million dollars. Yes, please kick me.

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  1. Pingback: Using a Spending Plan to achieve your goalsWe Got Outta Debt

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