Compound Interest

I came across this topic today in my news feed. The article by Susan Orman suggests that young people are missing the understanding of the power of compounding interest. This is related to the time value of money, meaning money today is worth more than money tomorrow. This is because money can be used, invested, or grown today. For example, if you invest $100 today, it can start earning interest or dividends. Susan illustrates the idea with the following example:

A 25-year-old who puts $100 into an S&P 500 index fund through a Roth IRA, every month until they are 65, assuming an annual interest rate of 12%. That person would retire with roughly $1.2 million in retirement savings. However, if they started saving at 35, their total would be just over $350,000. That works out to a difference of about $850,000 lost by beginning to invest just 10 years later.

Orman, 2023

Of course those results will not be typical but excellent for illustrative purposes. The main idea here is that over time a dedicated allocation of money into an investment not only produces value because of the automatic incremental investment but also because interest or dividends are being paid on the principal balance and as the balance grows so too does the interest and dividends paid.

Susan also goes on to talk about living within your means. This is a crucial concept to get and live by early in life. One of my mentors taught me about the phenomena called Lifestyle Expansion. In simple terms it means that your lifestyle (and what you spend money on) grows proportionally to your income. The more money you make the larger and more expensive your lifestyle becomes.

Susan also sponsors a pod cast called Women & Money (and Everyone Smart Enough to Listen). Time to check it out.