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Wednesday, October 24, 2012

The Magic of Compound Interest  -- Or --  How to Retire a Millionaire

Compound Interest is a powerful tool to building wealth over time.  Here’s the idea: you deposit money into a savings vehicle that pays you interest, such as a savings account, money market account, or mutual fund (the stock market).   Wait patiently!  Over time, your money earns interest and that interest earns interest.  After many years, even modest investments can grow to great sums.


Here’s an example:


Jennifer, age 20, invests $5,000 in a Roth IRA with an average return rate of 8%.  She does nothing else; she simply leaves it alone.  At age 65, that initial investment will now be worth $160,000 à a nice chunk of change for retirement.  

·         Investment = $5,000

·         Time = 45 years

·         Total at retirement = $160,000


If Jennifer waited until she was 39 to invest that $5,000 in a Roth IRA with the same return rate of 8%, the investment would only grow to $40,000.

·         Investment = $5,000

·         Time = 26 years

·         Total at retirement = $40,000


Starting early was the key!  Even better, if Jennifer can start early and make an investment of $5,000 every year, the growth is huge!  $5,000 each year will grow to more than $1.93 million.

·         Investment = $5,000 per year (over time, $225,000)

·         Time = 45 years

·         Total at retirement = $1,932,528


There are many compound interest calculators online.  Here’s an example where you can set your own investment amounts, whether it’s a one-time investment or monthly saving.  I ran the numbers on a small savings of $20 per month at 3% interest (something like a money market account).

·         Investment = $20 per month

·         Time = 15 years

·         Total = $4,593


How can you use the magic of compound interest?  Start saving now, even if it’s just a small amount.  Don’t touch the money and let time work for you.

By: Sarah Coats