The Miracle of Compound Returns
This video gives an easy-to-understand demonstration of the power of compounding and why it is so essential that you start saving early.
In this video, we use the miracle of compounding to explain why it's so important to save early and often.
Consider these two scenarios:
First, meet Myopic Mary. She starts saving in her 30s, and by 45 years old she has $20K. Her intended retirement age is 65. Mary invests her money in a retirement fund with a 7% annual rate of return. She doesn't touch the money until retirement. How much will she have by then? To get our answer, we'll use the Rule of 70.
The Rule of 70 lets you approximate the time it'll take for an investment to double, given a specified rate of return. To apply this rule, you divide 70 by the rate of return, and it'll tell you the years needed for the doubling. In Myopic Mary's case, her investment will double every decade.
With 20 years to save, she'll have roughly $80K by retirement.
Imagine though, that Myopic Mary goes back in time, becoming Meticulous Mary.
Meticulous Mary starts saving in her twenties. By 35, she has the same $20K to invest for retirement. Based on the Rule of 70, it'll still take 10 years for her money to double. But Meticulous Mary has a longer time horizon, from 35 to 65 years old. Thus, her money will double three times. Her final investment value will be $160K, compared to Myopic Mary's $80K.
That improved result comes through the miracle of compounding. Compounding gives you defined points where your money grows exponentially. The longer the time horizon, the more growth that occurs.
Now – where does opportunity cost fit into this? Well, for every dollar Myopic Mary invested at 45, that turned into four dollars by the time she was 65. For Meticulous Mary, every dollar invested at 35, turned into eight dollars by retirement. That's called winning the opportunity cost battle, through compounding.
Like we said, the right course is to save early and save often.
Source: Marginal Revolution University, https://mru.org/courses/money-skills/savings-and-compound-returns
This work is licensed under a Creative Commons Attribution-NoDerivatives 4.0 License.