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Retirement Planning Part 3 of 4: The Magic of Compounding

Retirement Planning Part 3 of 4: The Magic of Compounding

August 16, 2016

Legend has it that a reporter once asked Albert Einstein, a man long considered to be one of the smartest in the world, what he thought man’s greatest invention might be. His response: “Compound interest.”

No one knows if Einstein actually made this comment, but the thought is right on the money, so to speak. The magic of compound interest is why financial experts from all around the world consistently reinforce the importance of beginning to save for retirement sooner rather than later. The earlier you begin saving, the more your earned interest has the chance to grow.

Compound interest occurs when the interest that accrues to an amount of money in turn accrues interest itself. In other words, you’re earning interest on your interest. Some investors don’t get very excited when they hear about the potential for a 6% return on their money. In the short term that may be the case, but with a long-term horizon, that 6% can turn into real gains.

Let’s look at the hypothetical case of Cindy and Charlie, who each invest $100,000.

Charlie immediately begins depositing $10,000 a year in an account that earns 6% rate of return. Then, after 10 years, he stops making deposits. Cindy waits 10 years before getting started. She then starts to invest $10,000 a year for 10 years into an account that also earns a 6% rate of return.

Cindy and Charlie have both invested the same $100,000. However, Charlie’s balance is over $100,000 higher at the end of 20 years because his account has more time for the investment returns to compound. Compound interest transforms each penny you save over the years into a powerful income-generating tool.

* This is a hypothetical situation for illustrative purposes only and does not represent actual or future performance of any specific product or investment strategy.

As you consider your retirement savings plan, keep the key to compound interest in mind: Start early and stay the course. Your FAS Financial Advisor can help you determine the best plan for your individual needs.