Understanding compound interest is more than just learning about saving for retirement. It’s actually understanding how to get rich slowly, almost effortlessly. When a person starts saving early, even a modest return on the money they put aside in an interest-bearing account will create wealth over time.
If one starts early enough, does it enough, and is dedicated enough, they can even become a millionaire.
Unlike most wealth-creating plans, compound interest is unexciting. All someone has to do is set aside a certain amount of money at regular intervals in a savings account and watch the interest compound.
Slow and Steady
The reason it’s unexciting is that it’s a slow form of retirement planning. By comparison, buying real estate, stepping in and out of volatile financial markets, or building a business is exciting. There is a lot of action, wins, losses, risks, and rewards.
Still, over centuries, compound interest has been the most predictable way to become wealthy. Anyone who earns an income at any job can earn a fortune using this method. It calls for no special talent, takes little effort, and requires a minimum of attention. Despite these obvious benefits and the simplicity of this form of investment, it is often overlooked. In a span of five to ten years, it doesn’t really appear to be making that much of a difference in wealth accumulation compared to other methods with big returns on investment, but over a span of twenty to thirty years, it can be incredible: life’s golden ticket.
Start Saving Early and Stay the Course
The trick is to start early. If someone is in their twenties, contributes $5,000 to their Roth IRA and gets an 8% annual return, they will have $160,000 by age 65, when they are ready to retire. By comparison, if someone starts twenty years later, at age 40, their $5,000 by age 65 would only be around $40,000. This is assuming that the money is put in once and then left alone. However, if the twenty-year-old were to contribute $5,000 every year, then they would have $1.93 million by the time they retired at age 65. Thus, compound interest works even if there is a one-time contribution, but if there is a regular annual contribution, the return is about eightfold more.
Ideally, then, a parent should start a savings account for their child, and then persuade their child to continue to put money aside during their earning years. The earlier the retirement planning, the more money available in a person’s golden years.
Compound interest has often been described as a magical way of saving for retirement. In order to be successful at it, a person has to do three things: start early, invest regularly, and remain patient.