Compounding Interest

Compounding interest is the main reason why you should start saving for retirement as early as possible.  Time is compounding interest’s best friend.  Instead of earning interest on just your principle (the amount you put into the account), you also earn interest on any previous interest accumulated.

I won’t bore you with specific calculations but here is a great example that illustrates the power of compounding interest:

Mary and Shelly both put $2,000 into their retirement accounts every year but at different times in their lives.  Mary only put money into her retirement account from age 25 to age 33 (a total of $16,000).  Shelly on the other hand, didn’t start putting money into her retirement account until age 33 but she didn’t stop until she retired at age 65 (a total of $64,000).  Both of them earned 10% on their investments.

So who had more money in their retirement account at age 65?  Thanks to compounding interest, Mary did even though she saved a lot less money than Shelly.  Mary ends up with $531,188 and Shelly ends up with $442,496.

If you haven’t started saving for retirement yet, the best day to start is TODAY.


5 thoughts on “Compounding Interest

  1. Is this “retirement account” same as your typical “savings account”? Or is this something separate that needs to be set up?!

    • It is something separate that needs to be set up! You can set up an IRA on your own or use an employer sponsored plan like a 401k or in your case, since you’re a teacher, most likely a 403b. Did you find out if your school offers retirement plans yet?

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