It's a mistake to underestimate the cost of time. How much are we missing out on when waiting to invest?
Compound interest is the eighth wonder of the world. He who understands it, earns it … he who doesn’t … pays it. - Albert Einstein
How compounding works
The effects of compounding become stronger the more time we give an investment to grow. To get an idea of how powerful compounding can be and the difference it makes in the long run, let’s look at an example of our two friends, Casey and Alex. They are both 24 years old, employed, and have a 401(k) retirement account at work.
Casey is our responsible friend, and she starts participating in her 401(k) this year.
She sets aside $1000 a year towards retirement, contributing for the next 10 years, and then stops after that.
Alex, while responsible, prefers to live in the moment. He puts off saving for retirement for 5 years and spends the money on traveling.
After 5 years, he follows Casey’s footsteps and contributes $1000 a year until retirement.
At age 50, Alex contributed a total of $22,000 to his retirement account while Casey put in just $11,000. Yet, Alex's account is only slightly higher than Casey's at this point. Since Casey started 5 years before Alex, her investments began compounding sooner, helping her account grow faster longer.
The benefit of investing early
Starting early, even with a small amount, can result in a large multiplying effect on our money.
The huge difference between Casey's 1,150% gain compared to Alex's 363% gain is because Casey started investing 5 years earlier. It’s important to note that the effects of compounding are magnified by higher rates of return. E.g., at 1% growth, the difference would be much less noticeable. Historically, the average annual return of the S&P 500, an index broadly measuring the US stock market, has been around 10%.
By starting to invest earlier like Casey, the effects of compounding allow you to earn more despite contributing significantly less. Starting to invest early, no matter how small, and being consistent over time will lead to significant gains in the long run. Be patient; compounding will take care of the rest.