There is some debate as to whether Albert Einstein actually declared compound interest the greatest force in the history of the world. However, there should be absolutely no debate that whoever did utter those words was 100% correct. WHEN you start investing is much more important than how much you start investing. Allow me to explain.
Lets say there are two friends Dave and John, both 15 years old. Dave’s parents teach him the importance of saving and investing. Dave takes the money he earns at his first job and manages to save $1000 per year in a broad market index fund (such as NYSE:VTI) and manages to achieve the stock markets historical return rate of 10%. Dave does this for 10 years before he decides he wants to travel the world and stops contributing to the fund. He is smart enough however, to leave his nest egg in tact and at the ripe old age of 25 he has managed to save a little over $20,000.
John didn’t understand, or care about the importance of saving and investing. From the time he was 16 until the day he turned 45, John spent just about every dime he made. Turning 45 was a wake-up call for John, knowing that retirement was right around the corner and the fact he wouldn’t be able to count on Social Security or a pension for his retirement John started saving $10,000 per year and managed the same 10% rate as his old friend Dave. By the time John retires at age 65 he thankfully manages to save up just about $700,000. Dave, who stocked away $1000 for 10 years and then not another dime for the next 39 will end up with over $910,000! To further illustrate the point, keep in mind that Dave only contributed $10,000 of his own money while John had to shell out $200,000 from his own pockets.
To take things a step further, if Dave had invested that money in a Roth IRA he wouldn’t pay a penny in taxes on that $900,000 in retirement. While John, who had to play catch up wont be as lucky because even if he invested in a Roth IRA he would only be able to contribute $5000 per year, meaning that in addition to having less saved come retirement time, he’s also going to have to pay taxes on whatever amount he had to invest outside of a Roth.
What I’ve given here is a fairly elementary example, but the point remains. Due to the power of compounding, time is the greatest asset you have when investing for the long-term. So don’t procrastinate, contribute to that 401(k), open up a Roth IRA and keep a healthy savings account. When all the news about the stock market is bad, it’s actually the best time to start. You get to buy in at discounted prices and when the markets rebound they’ll do so sharply, taking you along for the ride.
If you’re older and don’t have much saved, don’t panic. You have a bit more work cut out for you, but even John from our example above managed to stock away nearly three quarters of a million dollars.
The power of compounding is really a beautiful thing once it gets working for you. After all, it’s because of the magic of compounding that they say making the first million is the hardest.
Late Edit: Try this calculator to see how compound interest will effect your savings: Financial Calculator