Consider two individuals trying to save for the future. John saves a hundred dollars a month into a magical investment that gives him 6% a year. After forty years, he ends up with a nice chunk of change: $199,149. Joe starts one year later, saves a hundred dollars into the same magical investment that gives him 6% a year. Do you know how much he gets after 39 years? $186,417.
$1,200 and an extra year gives John an additional $12,732 in savings. That’s over a ten times what he original contributed.
Let’s wait another year, what then? Let’s say we let Joe contribute the extra $1,200 and John stops his contribution. What then?
Joe ends up with $199,149, because forty years is still forty years, but John, with an extra year of savings, finishes 6% ahead – $211,098. For those keeping track at home that’s nearly $12,000 for almost nothing except waiting.
It’s Year 40, Not Year 1
Compound interest helps the person who saves early not because they started earlier, but because they have more time at the end for their money to grow. After year one, when Joe has saved nothing and John has saved $1,233, the difference looks so minor. Joe is only a little bit behind. The problem is when you look at year 40… after Joe has come to his senses. By then, the small little head start that John had in year 1 has magnified itself over forty years.
If you want a good sports analogy, golf is the perfect one. Small minute changes in your golf swing can dramatically change where the golf ball goes. If you don’t hit it square or have the club face tilted, the ball will hook or slice. Over even a hundred yards, the difference is great. The same is true for saving money and compound interest. Save early and you will reap the benefits later on.
Save Anywhere, Just Save!
One thing that hamstrings people is deciding how much to save and where to save it. Start small, just $1 a day means $30 a month. If you can manage $3, that’s $90 a month. Any amount greater than zero is better than nothing; action is better than inaction.
Where you save is up to you. If you want to put it in the stock market, invest it in index funds. If you are afraid of the stock market, put it in an online savings account or a high yield certificate of deposit where it’s 100% FDIC protected (up to $250,000). It doesn’t matter where as long as you start saving.
Don’t be like Joe, be like John and you’ll thank me in forty years. :)
Updated June 23, 2016 and originally published September 4, 2009.