THE SOONER YOU START setting aside money for retirement and other goals, the easier it will be to amass the necessary sums, partly because you will have more months when you’re saving and partly because you should benefit more from investment compounding.
Compounding is the process by which money grows over time. Imagine you started with $1,000 and earned 6% a year. During the first year, your $1,000 would earn $60, turning your $1,000 into $1,060. If that $1,060 again earns 6% during the second year, you’d be up to $1,124, as you notch gains not only on your original $1,000, but also on the $60 reinvested from the prior year. And so it goes on, with your $1,000 growing to $1,191 after three years, $1,338 after five years, $1,791 after 10 years, $3,207 after 20 years and $10,286 after 40 years.
The miraculous way that money compounds is captured by the rule of 72, a notion we also tackle in the chapter on investment math. If you take your expected rate of return and divide it into 72, you can find out how long it will take to double your money. For instance, at 6% a year, it takes 12 years to double your money.
The numbers are even more impressive if you combine investment compounding with saving regularly. Suppose you earn 6% annually and also save $1,000 a year. At that rate, you would have $5,975 after five years, $13,972 after 10 years, $38,993 after 20 years and $164,048 after 40 years.
Problem is, the benefits of both compounding and saving regularly can seem meager in the early years, because the main driver of your portfolio’s growth is the raw dollars you sock away. But if you keep at it for maybe a dozen or 15 years, you should reach a tipping point, where your annual investment gains start to surpass the annual amount you save. Suddenly, your portfolio will be hitting on both cylinders—and you may find your portfolio growing by leaps and bounds.
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