Compound Interest: The 8th Wonder of the World!
One of the first things I learned in finance class was time value of money calculations. For those not familiar with what the calculation entails, it involves entering inputs into a financial calculator such as number of years, interest rate, and other assumptions to determine a future amount. I was always amazed how much money I would have in the future if I was disciplined enough to save, generate a decent rate of return, and not take or limit withdrawals.
Business Insider recently published a study conducted by JP Morgan asset management that illustrates the very topic of time value of money. In the study, JP Morgan looked at 4 individuals that invested $10,000/year at over various time periods and varying return assumptions. Let’s examine the strategies employed by each of the four individuals that were featured in the study. Chloe invested $10,000/year from ages 25-65. Lyla started 10 years after Chloe, investing $10,000/year from ages 35-65. Quincy saved $10,000 from age 25-35 and then stopped. Finally, Noah invested $10,000 from ages 25-65; however, Noah used a lower return assumption of 2.25%, lower than the 6.5% assumed for Chloe, Lyla, and Quincy. So which portfolio did the best?
Not surprisingly, Chloe’s portfolio outperformed. Over her 40 years, her contribution of $400,000 turned into $1,870,480. Quincy was able to turn a contribution of $100,000 into $950,588 despite only contributing for 10 years and not saving a dime for the next 30. While Lyla contributed 3x what Quincy put in ($300,000), she actually ended up with a lower account balance. At age 65, Lyla’s account totaled $919,892 compared to Quincy’s balanced of $950,588.
It’s no wonder that compound has been described as the8th wonder of the world! To truly harness its power, a financial advisor can customize a savings plan that is unique to each person.
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Story Link: http://www.businessinsider.com/compound-interest-chart-march-2016-2016-3