Start saving in your 20s and become a millionaire by the time you reach your 60s through the power of compounding interest.
In this article:
- Why Save for Retirement
- Save Money Now
- Set Up Automated Deposits
- Consider Lifestyle Creep
- Think Big Picture
Be A Millionaire In Your 60s Through Compounding Interest
What is compounding interest? This is interest you earn on the money you already earned interest from. This interest is typically compounded annually, but can also be compounded monthly or quarterly.
Compound interest formula = Principal amount (1 + annual interest rate/compounding periods in a year)^(compounding periods in a year * total number of years)
Why Save for Retirement
If you’re currently in your 20s, chances are you’re working really hard to cover your daily needs like food and rent. There’s also a big chance you’re paying off some debt like credit card payments and student loans.
According to Chicago Tribune contributor and personal finance journalist Carla Fried, having all those expenses doesn’t mean you can’t start saving while you have time and compounding interest on your side.
Here are two reasons why you should start saving for retirement this early:
- Unless you’re lucky enough to receive a pension, it’s your responsibility to fund your retirement.
- Saving early means you can take advantage of continuously compounding interest for a longer period of time.
Save Money Now
When you save $100 each week in a high-yield savings account from age 25 to 65, you end up with $1.1 million (assuming you get a return of 7% each year). Only $208,000 of that comes from your savings.
The rest all comes from compounded interest. Investing in a Roth IRA or Roth 401(k) investment account allows you to enjoy that money tax-free.
On the other hand, if you wait until age 40, you need to save $300 a week to reach that same amount by 65. That amounts to $390,000 just from your own pocket.
Set Up Automated Deposits
$100 a week translates to $14/day. If you set up an automated deposit that transfers the money to your retirement account, you won’t feel the weight of the deductions as much.
This is all taken care of if you have a Roth 401(k) through your employer. If not, open a Roth IRA through one of the discount brokerages, then set your checking account to automatically deposit to your Roth IRA.
Give it some time to see if you can adjust your spending. If $100 a week is still too much to put away, you can always decrease the amount you deposit or even turn off the automated deposit.
Consider Lifestyle Creep
Before you decide on adjusting your retirement funding, take a closer look at your lifestyle.
- Pay off all your credit cards as soon as you can. Credit card debt is another example of compounding interest, but this is one that can work against you.
- Find a side hustle so you can earn, and in turn, save more money.
- Consider moving to a cheaper location or making housing adjustments like getting more roommates.
- Choose a good used car over buying a brand new car to save on car loan payments.
Think Big Picture
If you want a long term view of how your financial future could be by age 65, check out some periodic investment calculators.
Periodic investment calculators let you calculate different values for your weekly, monthly, or quarterly investments and the time you need to let the money grow to a certain amount. For example, if you have a portfolio composed of 70% equity and 30% bonds, you’d get a 9% rate of return per year.
Calculators allow you to see how much your money would grow if you start with a certain amount a week for a few years, then increase your investment once you have the means to do so. For example, when you save $100 between ages 25 and 35, then increase the amount to $200 until age 65, you will have $1.7 million when you retire.
There are many reasons why you should take advantage of compounding interest as early as possible. All those sacrifices you make during your prime earning years come back to reward you once it’s time to retire.
Have you started taking advantage of compounding interest? If not, what’s holding you back? Let us know in the comments section below.
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Carla Fried: By age 25, save $100 a week. In your mid-60s, have $1 million-plus – Chicago Tribune