“Try, try, try to understand, he's a magic man” – The Magic of Compound Interest and Money

It is commencement season on college campuses across the country – which means thousands upon thousands of drivel-ridden commencement addresses being laid upon new graduates. So in the spirit of anti-drivel, I wanted to talk about something more concrete than the typical platitudes of work hard, follow the golden rule, and dream big. So, to the graduating class of 2017 I say this -- “Try, try, try to understand, he's a magic man.”

Bear with me, I strongly identify as a musician so there will always be some degree of quality music education in my posts. So enjoy this worthwhile flashback to the 70s by Heart.

Compounding Interest

But in this case and back to the speech . . . the Magic Man (or Woman) is Compounding Interest. And more specifically, the Magic that compounding interest can do for you . . . (insert pregnant pause for dramatic effect) . . . right now, as a young person.

When you graduate college somewhere in your early 20s, the last thing you’re thinking about is retirement. You’re likely thinking about something quite the opposite. The average college graduate enters‘work life’ with huge student loan debt. Your degree may have cost you up to $200,000. Your first job is probably lousy. But hey, deal with it. Don’t pull a Costanza and live your parents.

And toil away from 9 to 5 only to spend almost as quickly as you earn. Instead, be different. Tweak your life to save as much you can in your 20-somethings. This is the path to independence and freedom. Here’s the big secret that we all seem to share in commencement addresses – It’s not about the money. It’s about the freedom and flexibility that building wealth can provide you. And compounding interest is the magic trick that can ensure you’re getting there . . . and fast.

It’s no secret that schools and universities don’t do a great job of preparing students to handle money. So once you’re out there in the real world, you’ll need to learn quickly – how to manage your student loans, build a monthly budget, create an emergency fund, and start saving for retirement.

You may be thinking – I don’t have investable assets and can probably wait a few more years to begin investing. Well, I’m here to tell you that you are 100% wrong. Because you have an asset of immense value: TIME. Time is an investor’s best friend and today’s magic trick.

Your Advantage

Two words. Save early. TWO VERY IMPORTANT WORDS. SAVE. EARLY. Simply put, compound interest occurs when your money accrues interest on the principal, and then successively earns even more interests on your previous interest plus principal. I know, I know. You need a visual.

This useful illustration from friends over at Money Under 30 is quick proof that the data doesn’t lie.

Here, Michael started off at 25 to save $1,000 each month until he turned 35. At this point, he stopped saving but left his money in his investment account where interest continued to compound at the rate of 7% annually until his retirement at age 65.

Jennifer, on the other hand, held off and waited till she was 35 to begin saving. She too, was able to put away $1,000 each month for 10 years until she was 45. Likewise, her investment account was left to accrue at 7% until she retired at age 65.

Lastly, we have Sam, who didn’t get around to investing until he was 45. Even though he also invested $1,000 monthly for 10 years and left it to accrue till age 65, let’s take a look at their significantly different ending balances:

Michael ------ $1,444,969
Jennifer ------ $734,549
Sam ------- $373,407

You don't need math to see that these three savers had put away the same amount ($120,000) over a 10-year period. So what’s your pick?

Find a way. Let’s get started.

OK. I know what you’re thinking. How on earth can I possibly save $1,000 each month? The fact is it doesn’t have to be $1,000. Start small before lifestyle inflation sinks in. It could be $50, $100 or $200. Do something. Anything. Find a low-cost option, no minimum option like Betterment or Robinhood and automate your savings. Do the research. Find the money.

Tips to Get You Started

Don’t delay saving. A dollar is worth more when invested today, rather than tomorrow.

Prioritize your spending; but also opt for a low-cost lifestyle that’s well within or below your earnings. College wasn’t that bad. Keep living the life. It will help you save more and avoid/reduce debt.

Don’t ignore the fact that your employer likely offers a 401K. Sign up. Take advantage of any matching benefits. And most important begin the process of educating yourself about your fund options, diversification, stocks vs. bonds, and asset allocation. You never stop learning.

And don’t forget. Set your sights high (oops, there’s a platitude, sorry). Decide what your financial goals are. And begin thinking about an investment plan that will get you there.

Questions?