Compounding: let time make you money
Advantages of being a young investor
If you’re a young professional in your twenties or thirties, you have an incredible advantage on your side: time. You can take this time you have and put it to work for you. If you start regularly investing in your twenties and thirties, you will have so much time to study investing, learn from your successes and failures, and experience the great power of compounding.
The power of compounding
Many people underestimate the power of compounding. On the surface, it looks and feels like not much is happening but if you stick with it you’ll see stellar results. Compounding allows your wealth to grow faster so you don’t have to put away as much money as you think to reach your goals.
Put simply, compounding involves drip-feeding smaller amounts of money into your investment accounts consistently, whether it be at a weekly or monthly rate. The money you invest then sits in the investment account and grows, giving you a much higher return over a long period of time.
To make it even better, the sooner you start means the harder time will work for you and your money. If you begin investing for retirement in your early to mid twenties, you will have a significant advantage over those who begin in their thirties.
How compounding works
The best way to understand the power of compounding is through a simplified example. Let’s say you start with an initial investment of $100. Using a hypothetical average annual rate of return of 5%, your initial investment will grow to $105 in the first year, $110.24 in the second year, $115.76 in the third, and so on and so forth. Without you even lifting a finger, your initial investment of $100 will have made you $15.76 in unrealized gains — and that’s without even drip-feeding smaller investments along the way.
Let’s take that same initial investment of $100, but this time continue to invest just $50 a month along the way. After the first year, your investment will grow to $735, then $1,401.75 in the second year, and $2,101.84 in the third. You’ll have made around $200 in 3 years without lifting a finger. If this still seems underwhelming, consider this: in 30 years, your investments will grow to about $40,000 with your total contributions sitting at around $18,000. You’ll have made roughly $22,000 in unrealized gains!
That’s why young investors have such an incredible advantage. A 22 year old that begins investing for retirement will have 40 years for their money to compound and grow. If we put a 22 year old in that same hypothetical investment strategy, they will have made around $49,000 by the time they retire (assuming they retire at 62).
Bear in mind, this hypothetical situation is very conservative. The idea of compounding only becomes more impressive when you consider monthly investments of $100, $200, or even $500 that allow you to exponentially increase your total returns.
Begin investing early and often
The bottom line is you should begin investing early and often. If you’re in your twenties and thirties, it’s time to start investing. Take advantage of time, make it work for you, and make preparing for retirement that much easier for yourself.