"I first met Mr. Compound Interest at the age of 24. I saw the power of his friendship and it blew my mind. He has been my guiding light for everything I do from saving, investing, living within my means, and most importantly, being excited for what the future holds."
- Derive Wealth -
Mr. Compound Interest is best introduced with a story. This is the exact same story I heard before I knew who he was.
It starts like this.
A TALE OF TWO TWIN BROTHERS
Meet twins Jimmy and Timmy.
Though they looked alike growing up, their personalities were unique.
Jimmy was a go-getter. Being independent was his dream. It started with his driver's license. Then moving out of the house. Then making his own money.
Jimmy got a job at age 20 and started saving money right away. He put away $5k into his 401k. He contributed the same amount each year for ten consecutive years.
He then stopped saving. Really stopped. Didn't save another dime in his 401k.
Timmy was a procrastinator. No guarantees for tomorrow was his motto. He liked being taken care of by his parents. Enjoyed being driven around town. And was in no hurry to get off his parent's "payroll".
He also got a job at age 20, but didn't save a dime. Spent everything he made.
At the age of 30, the lightbulb went off. He started saving $5k per year into his 401k. He continued to do so for the next 35 years.
BOTH INVESTED THEIR SAVINGS
Even though they started saving at different ages, both used the stock market to grow their savings.
For simplicity sake, let's assume they both received a hypothetical 8% annual rate of return in their 401k's.
BOTH RETIRE AT AGE 65
After long and successful careers, both decide to retire at age 65.
Who do you think ended up with more money in their 401k? Jimmy, who saved $5k per year for a total of only 10 years?
Or Timmy, who saved $5k per year for a total of 35 years?
The moment of truth.
Jimmy ended up with more money in his 401k. Almost $400k more.
How can this be possible?
How could Timmy save $125,000 more money and end up with almost $400,000 less?
That's the power of compound interest.
HOW IT WORKS
When you save money, it has the ability to grow.
In the stock market, this growth is called rate of return. In the bank it's called interest.
Let's look at an example and assume you save in the bank.
You start by savings $100 in a CD in January that pays 5% interest. By year end, your $100 has grown to $105. The extra $5 in your account is interest.
You make the decision to do it again the following year. You keep your money in the CD and let it ride.
Here is where compounding interest takes effect. The extra $5 you earned in interest the year prior will now also earn interest.
In other words, you will earn interest on the original $100 you started with plus the $5 you earned in interest.
This is called compounding interest.
By the end of year 5, your $100 has grown to $128, all by the power of compound interest.
BETTER WITH AGE
As you can see, the more time Mr. Compound Interest has to work, the more friends (money) he will make.
That's why Jimmy ended up with more savings than Timmy. His 45 years of letting compound interest take place vs. 35 years for Timmy was the deciding factor.
GO BACK IN TIME
Once you understand the power of compounding interest, the usual response is, "If I had only known..."
Well now you do. So get started!
Compounding interest is a great motivator. It makes saving just too important to neglect.
YOU HAVE HELP
We can help you decide how much to save and just as important, how to get the most interest, or rate of return, you can. Start today and put time on your side.
Derive Wealth is an independent, 100% fee-only financial planning firm located in Pasadena, CA. We specialize in creating personal financial plans designed to organize your life, get you to your goals, and take the worry out of your money. We don't sell products and don't work on commissions. Instead, we provide financial advice you can believe in.