Father Time doesn’t always have a good reputation, particularly when it comes to birthdays. But when it comes to saving for retirement, time might be one of your strongest allies. Why? When time teams up with the growth potential of compounding, the results can be powerful.
Time and money can work together
The premise behind compounding is fairly simple. Your invested dollars may earn returns from those investments, then those returns may earn returns themselves–and so on. That’s compounding.
Compounding in action
To see the process at work, consider the following hypothetical example: Say you invest $1,000 and earn a return of 7%–or $70–in one year. You now have $1,070 in your account. In year two, that $1,070 earns another 7%, and this time the amount earned is $74.90, bringing the total value of your account to $1,144.90. Over time, if your account continues to earn positive returns, the process can gather steam and add up.
Now consider how compounding might work in your retirement plan. Say $120 is automatically contributed to your plan account on a biweekly basis. Assuming you earn a 7% rate of return each year, after 10 years, you would have invested $31,200 and your account would be worth $45,100. That’s not too bad. If you kept investing the same amount, after 20 years, you’d have invested $62,400 and your account would be worth $135,835. And after just 10 more years–for a total investment time of 30 years and a total invested amount of $93,600–you’d have $318,381. That’s the power of compounding at work.
Keep in mind that these examples are hypothetical, for illustrative purposes only, and do not represent the performance of any actual investment. Returns are likely to be different each year, and are not guaranteed.
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