In Part 1 of the mini-series, we showed the power of exponential compounding returns. Today, let me show you an example of how time plays a big factor to compounding and why you should start investing early, even when you are an employee, to reap this benefit .
Starting early outweighs how much you save.
The chart below shows 2 investors, Amy and Bob. Amy invests $12,000 for 20 years year at 5% per annum (pa), between age 25 - 44, whilst Bob started 10 years later, invests $12,000 a year at 5% pa for 30 years, from 35 to 65. Another person, Charlie, who does not know how to invest and is more risk-averse, saves $12,000 a year for 40 years, from 25 - 65 before he retires.
At age 65, Amy has contributed $240,000 and is worth slightly over $1 million. Bob contributed $360,000 and his net worth is about $800,000. Charlie's contribution and his net worth at age 65 is about $500,000.
|
@ Age 65 |
Amy |
Bob |
Charlie |
|
Total Contribution |
$240,000 |
$360,000 |
$492,000 |
|
Net Worth |
$1,022,374 |
$837,129 |
$492,000 |
As Amy started early, even though she contributed 30% less than Bob, her net worth is 20% more than Bob. Notice Charlie contributed the most, yet he has the lowest net worth.
In this exercise, you realise that if you start investing at age 25 with $12,000 a year, even if you stop contributing after 20 years, you could be on your way to be a millionaire. You also realise that $12,000 a year is only $1,000 a month!
If we tweak the interest to a higher rate, the difference in gains of Amy over Bob and Charlie after some 40 years will be even greater!!
| @ Age 65 | Amy's Net Worth | Bob's Net Worth | Charlie's Net Worth |
| Interest of 3% pa | $561,350 | $588,032 | $492,000 |
| Interest of 5% pa | $1,022,374 | $837,129 | $492,000 |
| Interest of 8% pa | $2,507,948 | $1,468,150 | $492,000 |
| Interest of 10% pa | $4,552,133 | $2,171,321 | $492,000 |
| Interest of 12% pa | $8,243,322 | $3,243,511 | $492,000 |
| Interest of 20% pa | $85,719,941 | $17,019,095 | $492,000 |
Let Compound Interest do the work
So as you can see, in the previous article, we showed that you can achieve a sizeable return with a small capital, and starting early definitely beats starting later. So even if you just started working, by starting early with a small sum, and letting your investments exponentiate, you can achieve a sizeable return over time.
Would you rather work hard or let compound interest and time do the work?
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