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The Magic of Compounding

Even Albert Einstein called compounding "the greatest mathematical discovery of all time"

Don’t take our word for it. Even Albert Einstein called compounding “the greatest mathematical discovery of all time.” And, as with most “magic”—what is really going on is a lot simpler than you might think.

Here’s how it works:
» You save money in your retirement plan.
» The money you save earns money.
» The money your money earned earns more money.
» And so on.

Yes—it really is that simple. The really great thing is, the longer you save, the better compounding works for you.
In fact, saving a little for a long time generally adds up quicker than saving a lot for a short period of time—and it’s a lot easier, too.
Here is a quick example: Assume you save $1,000 a year (that’s only about $20/week). At the end of a year, that $1,000 could be worth about $1,100, assuming a 10% rate of return (which we chose to keep the math simple).
You keep saving $1,000 a year and, after 5 years, you could have a total of $6,300. That’s right; your $5,000 has grown by more than 25%. That is the “magic” of compounding—and it will work for you in your retirement savings plan.
However, it doesn’t stop there.


That savings of $1,000/year can keep growing for you, and the longer you let it grow, the faster it will add up. Incredible as it seems—as you can see—after 15 years, the earnings in your account are nearly equal to the total contributions you made yourself. Just imagine what can happen if you put in more than $1,000. Now, you may not earn 10% every year—or even in any year, depending on when you start and where you choose to invest. In a very real sense, time is money when it comes to saving for retirement and, as you can see in the simple chart below, the impact over time is nothing short of magical. This is one time when something that seems “too good to be true” isn’t.

Start Saving Now

Thanks to compounding, saving a little early is better than saving a lot more later. For example, assume *Investor A sets aside $2,000/year for 10 years, roughly $40 a week. Then, because of other financial obligations—perhaps a house payment—A is not able to save anything more for the next 20 years. On the other hand, **Investor B, who begins work at the same time as A, does not save anything during his first 10 years of employment. Instead, he decides to wait until he can “afford” it. Then, he saves $2,000/year for the next 20 years—$40,000.
At the end of 30 years, B could end up with nearly $100,000, assuming an 8% return. However, A, who was only able to save half as much as B, could have nearly $146,000.
 

PLANSPONSOR staff
editors@plansponsor.com