The power of compound interest: Earlier you save, the better


One of the most important things to understand about money is that a dollar today is worth more than a dollar tomorrow. The time value of money assumes a dollar now is worth more than a dollar in the future, because of variables such as interest rates and inflation.

If you have $100 and do nothing with it, the value of that money will decline as time goes by. But if you put that $100 into a savings account or other type of investment account, it will start to earn interest, and that $100 will grow into a much bigger sum of money.

The power of compound interest

Compound interest is an extremely powerful force that allows investors to earn exponentially larger gains on their money over time — so, again, the money you save now is worth a lot more than the money you save later.

Here’s a simple example: You invest $1,000 today and earn an annual 5% gain, so $50. That $50 is added to the principal amount of your investment, and then next year, you earn a 5% gain on $1,050, so you earn $102.50. And so on…

The earlier you start saving, the better.

Here’s another example: if a 16-year-old saves $2,000 annually for six years, putting the money into a Roth IRA account, and stops at age 21, he or she would have $1 million by age 65.

This assumes a 9.4% average gain annually, which has been the average return on the stock market since 1926.

So the earlier you start putting money away in a retirement account, the more time it has to earn you a lot more money. If you keep telling yourself you can always save later, and even if you do contribute a lot more later than you would now, that money still wouldn’t have the time to grow like it would if you saved now.

Saving money early — not even often, just early — will still ultimately lead you to bigger wealth at the time of retirement. Imagine if that 16-year-old continued to save way beyond just six years — that sum of money would at least double.

Here’s how much you need to save to be a millionaire by the time you retire.

More resources to start investing: