For long-term investment goals such as retirement, time can be one of your biggest advantages. That’s because time allows your investment dollars to do some of the hard work for you through a mathematical principle known as compounding.
The snowball effect
The premise behind compounding is fairly simple. You invest to earn money, and if those returns are then reinvested, that money can also earn returns.
For example, say you invest $1,000 and earn an annual return of 7% — which, of course, cannot be guaranteed. In year one, you’d earn $70 and your account would be worth $1,070. In year two, that $1,070 would earn $74.90, which would bring the total value of your account to $1,144.90. In year three, your account would earn $80.14, bringing the total to $1,225.04 — and so on. Over time, if your account continues to grow in this manner, the process can begin to snowball and potentially add up.
Time and money
Now consider how compounding works over long time periods using dollar-cost averaging (investing equal amounts at regular intervals), a strategy many people use to save for retirement.1 Let’s say you contribute $120 every two weeks. Assuming you earn a 7% rate of return each year, your results would look like this:
|Time period||Amount invested||Total accumulated|
After 10 years, your investment would have earned almost $14,000; after 20 years, your money would have more than doubled; and after 30 years, your account would be worth more than three times what you invested.2 That’s the power of compounding at work. The longer you invest and allow the money to grow, the more powerful compounding can become.
The cost of waiting
Now consider how much it might cost you to delay your investing plan. Let’s say you set a goal of accumulating $500,000 before you retire. The following scenarios examine how much you would have to invest on a monthly basis, assuming you start with no money and earn a 7% annual rate of return (compounded monthly).
|Time frame to retirement||40 years||35 years||30 years||25 years|
|Retirement accumulation goal||$500,000||$500,000||$500,000||$500,000|
|Annual rate of return||7%||7%||7%||7%|
|Monthly contribution needed||$190||$278||$410||$617|
So the less time you have to pursue your goal, the more you will likely have to invest out of pocket. The moral of the story? Don’t put off saving for the future. Give your investment dollars as much time as possible to do the hard work for you.
1 Dollar-cost averaging does not ensure a profit or prevent a loss. It involves continuous investments in securities regardless of fluctuating prices. You should consider your financial ability to continue making purchases during periods of low and high price levels. All investing involves risk, including the possible loss of principal, and there is no guarantee that any investment strategy will be successful. Review your progress periodically and be prepared to make adjustments when necessary.
2 Assumes 26 contributions per year, compounded bi-weekly.
These hypothetical examples are used for illustrative purposes only and do not represent the performance of any specific investment. Fees and expenses are not considered and would reduce the performance shown if they were included. Actual results will vary. Rates of return will vary over time, particularly for long-term investments. Investments with the potential for higher rates of return also carry a greater degree of risk of loss.
Copyright 2006-Broadridge Investor Communication Solutions, Inc. All rights reserved.
Broadridge Investor Communication Solutions, Inc. does not provide investment, tax, or legal advice. The information presented here is not specific to any individual’s personal circumstances.
To the extent that this material concerns tax matters, it is not intended or written to be used, and cannot be used, by a taxpayer for the purpose of avoiding penalties that may be imposed by law. Each taxpayer should seek independent advice from a tax professional based on his or her individual circumstances.
These materials are provided for general information and educational purposes based upon publicly available information from sources believed to be reliable—we cannot assure the accuracy or completeness of these materials. The information in these materials may change at any time and without notice.
*Non-deposit investment products and services are offered through CUSO Financial Services, L.P. (“CFS”), a registered broker-dealer (Member FINRA / SIPC) and SEC Registered Investment Advisor. Products offered through CFS: are not NCUA/NCUSIF or otherwise federally insured, are not guarantees or obligations of the credit union, and may involve investment risk including possible loss of principal. Investment Representatives are registered through CFS. Coastal Federal Credit Union has contracted with CFS to make non-deposit investment products and services available to credit union members.
CFS representatives do not provide tax or legal guidance. For such guidance please consult with a qualified professional. Information shown is for general illustration purposes and does not predict or depict the performance of any investment or strategy. Past performance does not guarantee future results.
Trust Services are available through MEMBERS Trust Company. CFS* is not affiliated with Members Trust Company.