So you want to be rich? The magic of compounding interest:

What if you were able to save half your income every month? To make the math simple, lets say you earn $12,000* a year ($1,000 a month), and you’re able to put half of it ($500/month) into a mutual fund account ($6,000/year). You’re a very conservative investor, and the market isn’t very good, so you end up getting the unfortunately low rate of 4% on your investment. How long will it take before the mutual fund account generates more money in interest than the $6,000 you’re contributing annually?

Image

From left to right: years, dollars you contribute that year, interest generated, your total contribution to the account, total interest accumulated, and total account value

It looks like under less than ideal market conditions, you’ll be banking $6,089** in year 18 of your investment.  You’ll also be sitting on $158,322 in savings, nice!  What else is impressive about the chart above? It took us 18 years to reach $6,000/year, but only 2 short years to reach $7,000/year in interest. In fact, in year 28 you’ll be making $12,023! Like in Settlers of Catan, the advantage of investing early is multiplied later in the game. Unfortunately, this also means that the early going is fairly boring, putting $6,000 of your cash into an account that earns you only $131 in the first year can feel a lot like flushing good money down the toilet. It is also likely that your earning power in your late teens and early twenties may be considerably less than later on in life, making it even harder to part with your hard-earned dollars. But remember, later on in life, you will have more expenses as well, at some point you may want to have a family, and you’ll thank former you for taking such good care of future you.

With this compound interest calculator, you can play with the numbers yourself!

*I’m aware that saving $500 on a monthly budget of $1,000 is pretty damn tight, $1000 a month is also less than federal minimum wage for full time work (that would be $1,260/month before taxes, or approximately $15,000/year). My budget is $954 a month and doesn’t feel constricting at all, but I’d have earn at least $1,454 to put away $500. I wanted to keep the math simple though, and I think putting away half your income is a good target, so I kept the numbers.

**of course that $6,089 is subject to inflation over the 18 years, so it won’t buy you the same quality of life as $6,000 did when you began, but its still a significant amount of money! You can account for the inflation by increasing your monthly contributions to keep up with inflation, all of which you can calculate using the compound interest calculator above.

Advertisements
This entry was posted in Uncategorized and tagged , , , , . Bookmark the permalink.

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s