The Power of Compound Interest

Two students graduate from college and enter the work world. Student A is really diligent about immediately saving for her retirement. So she puts $3000 per year into her Individual Retirement Account each year for the next 10 years. But ten years later, she feels so strapped for funds due to the fact that she is now a stay at home mom and she and her husband just bought a house and have a hefty mortgage. Student B doesn’t put anything at all into her retirement from ages 22 to 32. She doesn’t even want to think about retirement. But now at 32, she feels more mature and realizes that she should start saving. So starting at age 32 – ten years after Student A started investing for her retirement – Student B starts putting in $3000 per year every single year. Each of these accounts are going to average an 8% return per year.

How many years will Student B have to invest her $3000 to surpass the total in Student A’s account? Remember, Student A put in $3000 per year each year for 10 years, and then stopped putting money into the account entirely. Student B put nothing in from ages 22 to 32. But is now putting in $3000 every single year. When will the amount in her Individual Retirement Account surpass the total in Student A’s account?

The answer? The answer is never. Student B could put money into her account for the rest of her life and she'll never ever catch up to the amount in Student A's account. The reason is due to the power of compound interest. The key to building up a nice nest egg is to start saving and to start saving now. Even if you can't afford to save much, get into the habit of always saving at least something. It's a habit that will pay hefty dividends later in life.