Investment Snowballs and the magic of compounding

[Clarkfan2]

USATODAY.com

Snowballs and the magic of compounding

Tuesday December 27, 11:01 pm ET

 

Link to USATODAY article

 

Note: Online calculator in artcile below by hitting blue hyper link that says Online Calculator

 

Q: I want to start investing, but I only have $500 to $1,000 to start with and can only invest about $100 a month. How much can that be worth in 30 years and what should I invest in?

A: Famed physicist Albert Einstein is supposed to have said that the most powerful force in the universe is compound interest.

 

 

That's quite a statement from the man who is credited with discoveries that paved the way for the atomic bomb.

 

But it's true. Compound interest describes how investments can snowball over time. Just as a snowball gets bigger and bigger and rolls faster and faster as it tumbles down a mountain, the same can be true with your investments. Due to the power of compounding, the value of your portfolio can grow faster each year because you earn interest not only on what you invested, but also on the interest you earn.

 

Say you invest $500 one time and get 5% interest each year. Compounding starts out pretty underwhelming. At the end of the first year your $500 investment will be worth $525.

 

But the magic begins the next year. Instead of just getting $25 in interest, you will get $26.25 (5% of $525). And as time goes on, the interest gets larger and larger. Over 30 years, the interest will total $2,160. That's much more than the $25 a year ($750) that would have built up without compounding.

 

Not surprisingly, if you make more than one deposit to your account and reinvest the interest, the power of compounding is put on steroids. And, if you properly invest your money in a diversified portfolio and get better returns, such as 10%, the results are even more remarkable.

 

But let's go back to your example of a $500 initial deposit and $100 invested each month with 10% returns. That kind of return should be possible if you invest in a diversified basket of stock indexes. For more help on how to allocate your portfolio, read this.

 

Finally, using a financial calculator we can see that the initial $500 deposit will be worth $235,967 in 30 years. You can calculate this yourself by using this online calculator. Online Calculator

 

Matt Krantz is a financial markets reporter at USA TODAY. He answers a different reader question every weekday in his Ask Matt column at money.usatoday.com. To submit a question, e-mail Matt at mkrantz@usatoday.com

Edited December 28, 2005 by Clarkfan2

[hegemony]

another reason to not delay savings (even if it means not being out of debt).

[Clarkfan2]

Not so fast...

 

Compounding interest can work against you (debt) just as easy as for you. There are many here in the forum that have double digit APRs on credit cards that need to pay them off first!

[Amaysing1]

Great article and great response.

[hegemony]

Not so fast...

 

Compounding interest can work against you (debt) just as easy as for you. There are many here in the forum that have double digit APRs on credit cards that need to pay them off first!

LOL. you and I have gone 'round and round on this. I still say it is worth it for people to start investing/savings earlier rather than later. For one it helps build a habit of saving and investing. SEcondly taking advantage of pre-tax retirement vehicles can have other benefits.

[54regcab]

IMHO it depends if the person is commited to a debt-free lifestyle. If you have the attitude you will always have a car payment and owe VISA go ahead and start investing NOW.

[Athena53]

This is major.

 

I'm 52. According to my calculations (6% return on investment, 4% inflation, I can withdraw 4% of my assets every year starting at retirement), every $10,000 I add this year to my savings will add- woo hoo!- $500 (in 2005 dollars) a year to my annual income at retirement.

 

In other words, you CANNOT posptpone saving for retirement till your kids get out of college or you're dead. Fortunately, I have a nice pile accumulated although now I wish it were more. The earlier, the better even if it's just a little. It's also good to make your investment mistakes early (I certanly made my share) while you're young enough to recover from them.

[hegemony]

This is major.

 

I'm 52. According to my calculations (6% return on investment, 4% inflation, I can withdraw 4% of my assets every year starting at retirement), every $10,000 I add this year to my savings will add- woo hoo!- $500 (in 2005 dollars) a year to my annual income at retirement.

 

In other words, you CANNOT posptpone saving for retirement till your kids get out of college or you're dead. Fortunately, I have a nice pile accumulated although now I wish it were more. The earlier, the better even if it's just a little. It's also good to make your investment mistakes early (I certanly made my share) while you're young enough to recover from them.

very well put!

 

I wish I would had started even $50 a month in a ROTH years before I did (especially since in 2005 and 2006 we can not contribute to ROTHs anymore).

 

In my first job it took 12 months before you could sign up for the matching for retirement. I COULD HAVE -- but stupidedly did not -- make my own contributions from date of hire.

[Uncle Leo]

Not so fast...

 

Compounding interest can work against you (debt) just as easy as for you. There are many here in the forum that have double digit APRs on credit cards that need to pay them off first!

LOL. you and I have gone 'round and round on this. I still say it is worth it for people to start investing/savings earlier rather than later. For one it helps build a habit of saving and investing. SEcondly taking advantage of pre-tax retirement vehicles can have other benefits.

 

While I understand, and partially agree with, Clarkfan's point, I feel that this point about building a positive habit should not be underestimated.

[Clarkfan2]

I'll conceed...

 

I like savings and the positive habit of saving.

 

While I understand, and partially agree with, Clarkfan's point, I feel that this point about building a positive habit should not be underestimated

.

 

I conceed that saving up to the match in a 401k especially if it is being matched at 25%,50% or 100% would be better than paying off consumer debt. I've always believed this but had forgotten about this common exception to paying it all off (debt) first. I always say take the free money off the table (in the form of 401k match) unless you are not current with your bills.

 

 

Clark