Small Amounts Add Up
A journey of a thousand miles begins with a single step. When thinking about retirement savings, many people feel overwhelmed and avoid getting started because daily life and expenses make it difficult. While that is true, making some small changes can have a tremendous impact on financial flexibility in retirement.
Albert Einstein famously stated: “Compound interest is the eighth wonder of the world. He who understands it, earns it ... he who doesn't ... pays it.” Relative to retirement savings, compounding interest can be extremely powerful over time. By compound interest, it means that interest is earned on interest already earned. Which can really add up! For example, if an investor started with $100 and earned 10% on it each year, after the first year she would have $110. In the second year, she would earn $11, which brings her balance to $121 – and so on. That may not seem like much at first, but there’s a handy mathematical formula to illustrate the power over time, the “Rule of 72”. This rule is an easy way to estimate the time required to double your money –72 divided by the annual return rate gives you the number of periods needed to double. For example, at a 10% return, money doubles every 7 years. At a 7% return, money doubles every 10 years.
That concept is especially powerful when investors start saving early in life. For example, if the investor above is 23 years old when she saved the $100, there are approximately 6 periods of doubling before she retires. That means the initial $100 saved could be nearly $6,400 at retirement when she’s 65 ($100 x 2 x 2 x 2 x 2 x 2 x 2). Now $6,400 isn’t going to buy a lot of European riverboat cruises, but if an investor can make saving and investing a habit, she might be saving $100 per paycheck – and now we’re really talking about financial flexibility. That saving might be hard to accomplish at times, but whether it’s $10 or $1,000, building a habit to “pay yourself first” with savings will be that step that helps you achieve a much longer journey.
Is 10% a realistic expectation over the long term? Maybe not, but there have been fairly long periods where the average return in the stock market has achieved that. So, when investors have a long time horizon – or the period before they plan to take distributions – many can afford more risk to achieve the returns needed to take advantage of compounding returns. There will no doubt be volatility along the way, but even that isn’t necessarily a bad thing for investors in their early “accumulation” years.
In summary, saving a small amount may not seem like it’s worth it now, but that amount can certainly add up over time & create a habit that supports great financial flexibility in retirement. We encourage participants?? to “pay themselves first” and take advantage of savings opportunities while time is on their side, to invest for growth, and leverage the power of compound interest to achieve success on their financial journey.