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Time Is on Your Side – The Magic of Compound Interest

Delta Community and other credit unions around the country are offering free financial advice for children and teenagers during April, National Youth Savings Month. While young people are usually unconcerned about how they will fund their future, they are in the best position to capitalize on two important elements which can turn even small savings accounts into virtual money-making machines. Those two magic ingredients are time, which young people have in abundance, and compounding interest.

Compound interest is money earned on the interest earned by your original investment, or principal. It’s an amazing phenomenon, but one that is important for young people to understand, since they have the time needed to realize maximum earnings from compound interest.

Here’s an example of how it works. Megan, David and Kent will receive the exact same 7% annual investment return on their retirement funds. The only difference is when and how often they save.
  • Megan begins investing $5,000 each year beginning at age 18 and continuing for 10 years. At age 28, she stops and never invests another dime. Over that 10-year period, Megan set aside a total of $50,000. By the time she turns 58 years old, that $50K will grow to more than $602,000 – thanks to compound interest.
  • David also invests $5,000 annually, but he doesn’t start until he is 28 years old. David works hard to invest $5,000 annually for 30 years! Even though he invests a total of $150,000, at age 58 his savings will amount to about $540,000. His nest egg earned $60,000 less than Megan’s because she had an additional 10 years to earn compound interest.
  • Kent, on the other hand, starts investing early and keeps going. He begins investing $5,000 annually at age 18 and continues until he is 58. Kent invests a total of just $200,000, but because he began early, the interest he earns has 40 years to keep building on itself. By the time Kent reaches 58 years old, he will have more than a million dollars in his account.

the magic of compound interest

It may not be surprising that Kent’s total is higher, since he saved money for a longer period of time. Consistent and, more important, an early start, allowed his savings to snowball.

But some people may be surprised that Megan’s account is so much bigger than David’s. After all, she stopped investing altogether after just ten years. David invested the same amount annually for 30 full years, but never caught up with Megan. That is the magic of compound interest.

If you are a young adult just starting out on your own, many expenses compete for your money. It can seem impossible to save for the future. But try to remember that early investment in interest-bearing accounts will give you a huge financial edge – no matter what you are saving for.