Consider this hypothetical investing decision: If you were given the choice between receiving $10,000 a day for thirty days or a penny that doubles in value each day for the same thirty days, which would you choose? While the first option adds up to $300,000, the second would net you close to $5 million.
The riddle illustrates the magic of compounding, which involves taking earnings and then regularly reinvesting them in order to generate further earnings – in this case, doubling the amount of each penny from the day before – in helping us achieve our financial goals.
Compounding depends on three factors:
- The amount of money you invest
- The length of time the investment grows
- The rate of return the investment yields
Start as Early as Possible
One of the best tips for building a nest egg is simply to start investing as early as possible. For example, at age 21, both Anne and Stacy were hired at the same salary. Anne immediately began setting aside $30 per week, doing so for fourteen years before she stopped contributing any new funds to what she’d already saved. Anne then allowed her earnings to compound for thirty more years at 6.3%.
Stacy, on the other hand, waited until age 35 to put aside $30 per week and did so for thirty years—over the course of time contributing more than twice as much as Anne while earning the same rate on her investment.
At the end of thirty years, Anne’s investment would be far larger than Stacy’s, even though Anne stopped contributing when she was 35. Anne’s investment would have grown to approximately $209,000, while Stacy – who invested twice as much but got off to a later start – would have accumulated around $130,000.
We’re Here to Help
Compounding is a simple concept that, no matter your stage in life, can make your money work for you. Remember that our CFS* Financial Advisors are available to answer your questions and provide guidance, and are available by calling 415.674.4845 (Dennis) or 415.674.4846 (Stephen).
Figures quoted are for illustrative purposes only, are solely based on the rates of return stated, and are not necessarily indicative of past or future results of any specific investment. Investment returns and principal value will fluctuate with market conditions and could lose value.