The Benefits of Compounding and Small Changes

Client Centered

April 2024 | Joshua Rapp| Retirement Specialist

We all want to have a large retirement nest egg when we reach retirement age.  So what’s the best way to do this?  The answer is pretty obvious, start early and be consistent.  This is an easy concept to remember and strive for, but it’s also sometimes very hard to follow.  Let me give you an example of the power of compound interest in hopes that it will make this goal even more of a priority for you.  I understand that life usually gets in the way of trying to save, but it could be much more costly than you realize.

Imagine we have 2 investors, Cindy & Charlie.  Both are age 25 currently and looking to retire at age 65.  Cindy starts right away at age 25 investing $5,000 a year.  She invests consistently for 10 years and then stops investing.  Charlie on the other had, waits until he’s more comfortable and doesn’t start investing until he’s 35 years old.  He invests the same $5,000 a year that Cindy did, but he stays consistent and keeps investing for 30 years until he’s ready to retire at age 65. Both Charlie and Cindy earn a hypothetical 8% rate of return on their investments. 

The power of compounding provides Cindy with a higher overall balance at age 65 even though she only invested for 10 years, and Charlie invested for 30 years.  The initial balance Cindy built in the first 10 years with the compounding for the next 40 years gives her just over $175,000 more than Charlie in this scenario.  Charlie ends with a balance of $611,730 at age 65 while Cindy ends up with a balance of $787,180. 

The best advantage you have when saving for retirement is time, use it wisely and it will pay off in a big way at the end. 

You may be thinking..."I can’t afford to save right now,” and I get it, there are plenty of other things that get in the way of saving; debt payments, housing costs, emergency funds, student loans, etc.…

My advice is to start small, then increase slowly over the coming years.  This allows you to at a minimum start the process and get the budget acclimated to saving.  Then each year, maybe at the same time you are due a raise or cost of living adjustment to your pay, increase your contribution by 1%. 

Let’s say you start at 3% because that is all you can afford right now.  Then next year, you increase to 4%, and the following year, increase to 5% and ongoing.  Before you know it, you’ll be saving over 10% and you’ll barely feel it if you do it systematically and consistently. 

A hypothetical example of 1% difference can yield a much larger nest egg when in retirement.  For instance, if you were making $50,000 a year and contributing 5% of your pay, your nest egg at retirement would be $294,321 assuming an 8% return.  By increasing to 6%, just 1% more, your nest egg would be $353,185.  This assumes 30 years of investing and only shows 1% difference.  Imagine if it was a 1% each year difference, your nest egg would grow exponentially.

Again, the biggest advantage you have when saving for retirement is time.  Start small and grow slowly and it will pay off. 

Our first priority is helping you take care of yourself and your family. We want to learn more about your personal situation, identify your dreams and goals, and understand your tolerance for risk. Long-term relationships that encourage open and honest communication have been the cornerstone of success. If you have any questions, please reach out using our contact page or contact Joshua directly.