Introduction
Previously, we explored the tremendous power of compounding and how it can help achieve significant financial milestones. This follow-up article focuses on another critical aspect of successful investing: time! We will model three scenarios to illustrate how starting at different ages impacts the final investment value at age 65. Each scenario involves a $500 monthly investment, assuming an average annual return of 10% from the S&P 500 with dividends reinvested. By comparing these scenarios, we will demonstrate why starting early can substantially impact your financial future.
Key Terms and Concepts
Before diving into the scenarios, let’s briefly revisit some key terms and concepts:
- Compound Interest: Interest calculated on the initial principal, which also includes all accumulated interest from previous periods.
- Principal: The initial amount of money invested.
- Rate of Return: The percentage of profit or loss on an investment over a specified period. For our scenarios, we use a 10% average annual return.
- Time Horizon: The length of time over which an investment is held.
Investment Scenarios
Early Earl: Investing $500/Month from Age 25 to 35
Early Earl starts investing $500 monthly for 10 years and never adds another dollar to his investment accounts. The money is left to grow with the power of compounding until age 65.
Initial Age: 25
Final Age: 65
Monthly Contribution: $500
Contribution Period: 10 years (age 25 to 35)
Total Contributions: $60,000
Annual Rate of Return: 10%
After compounding at a 10% rate for 10 years, Earl will have a balance of approximately $95,625 at age 35.
At this point, Earl does not add one more dollar to his account but stays invested in the S&P 500 and keeps reinvesting dividends, generating an average annual return of 10%. At age 65, Earl has an account balance of $1,668,599.
On contributions of only $60,000, Earl has amassed over $1.6 million.
Delayed Dennis: Investing $500/Month from Age 35 to 45
Delayed Dennis waits until age 35 to start investing, contributing $500 monthly for 10 years, and then stops. The money is left to grow with the power of compounding until age 65.
Initial Age: 35
Final Age: 65
Monthly Contribution: $500
Contribution Period: 10 years (age 35 to 45)
Total Contributions: $60,000
Annual Rate of Return: 10%
After compounding at a 10% rate for 10 years, Dennis will have a balance of approximately $95,625 at age 45.
At this point, Dennis does not add one more dollar to his account but stays invested in the S&P 500 and reinvests dividends, generating an average annual return of 10%. At age 65, Dennis has an account balance of $643,317.
On contributions of only $60,000, Dennis has amassed over $640,000.
Although both Earl and Dennis contributed $60,000, Earl had more than $1,000,000 more than Dennis at age 65 simply by starting 10 years earlier. Time is the most powerful variable for compounding your investments!
Late Larry: Investing $500/Month from Age 45 to 65
Late Larry realizes he is late to the investing party, so he starts contributing $500 per month for 20 years, from age 45 to 65, instead of only for 10 years like Earl and Dennis.
Initial Age: 45
Final Age: 65
Monthly Contribution: $500
Contribution Period: 20 years (age 45 to 65)
Total Contributions: $120,000
Annual Rate of Return: 10%
After compounding at a 10% rate for 20 years, Larry’s balance will be approximately $378,015 at age 65.
On contributions of $120,000, Larry has amassed over $378,000.
Conclusion
The three scenarios clearly illustrate the profound impact of starting early in investing. Here’s a summary of the results:
- Early Earl (Start at 25, invests for 10 years): $1,656,823 at age 65
- Delayed Dennis (Start at 35, invests for 10 years): $636,653 at age 65
- Late Larry (Start at 45, invests for 20 years): $382,848 at age 65
Larry contributes twice as much as Earl and Dennis, and his balance at age 65 is significantly lower. How does this happen? Larry simply doesn’t have time on his side. Earl contributes half as much as Larry but ends up with over $1 million more at age 65. This is the magic of compound interest. Invested money grows exponentially over time, so the more time you give yourself, the more money you will have.
Key Takeaways:
- Start Early: The earlier you start investing, the more time your money has to grow. Even small contributions can lead to substantial wealth over time due to compounding.
- Consistent Contributions: Regular, consistent contributions are crucial. Set up automatic investments to ensure you stay on track.
- Time in the Market: It’s not about timing the market but about time in the market. The longer you stay invested, the better your returns will be.
- Patience and Discipline: Successful investing requires patience and discipline. Stay the course and avoid the temptation to withdraw early or make impulsive decisions.
By understanding and leveraging the importance of starting early, you can significantly enhance your financial future and confidently achieve your life’s important milestones. Whether you’re just starting your career or approaching retirement, it’s never too late to start investing. However, the earlier you begin, the greater the benefits you will reap. Start today and let the magic of compounding work in your favor.
The information contained herein is intended to be used for educational purposes only and is not exhaustive. Diversification and/or any strategy that may be discussed does not guarantee against investment losses but are intended to help manage risk and return. If applicable, historical discussions and/or opinions are not predictive of future events. The content is presented in good faith and has been drawn from sources believed to be reliable. The content is not intended to be legal, tax or financial advice. Please consult a legal, tax or financial professional for information specific to your individual situation.
This content not reviewed by FINRA
Northbrook Financial is an Investment Adviser registered with the State of Maryland. All views, expressions, and opinions included in this communication are subject to change. This communication is not intended as an offer or solicitation to buy, hold or sell any financial instrument or investment advisory services. Any information provided has been obtained from sources considered reliable, but we do not guarantee the accuracy or the completeness of any description of securities, markets or developments mentioned. Please contact us at 410-941-9709 if there is any change in your financial situation, needs, goals or objectives, or if you wish to initiate or modify any restrictions on the management of the account. Our current disclosure brochure, Form ADV Part 2, is available upon request, and on our website https://www.northbrookfinancial.com