You’ve probably already glanced down and seen the image and thought, “What’s so special about that?” But let me break it down for you and you will see the incredible power that this image represents.
This is a graph of what happens when someone invests $160 per month for 45 years (such as from age 20 to age 65) and gets an average rate of return of 9%:
The first two things I want you to notice about this image are:
- At the end the balance is over $1 million. This person is only contributing $160 per month, but they end up with over $1 million! This is the power of compounding, which is when your interest earns interest.
- For the first 10 years, or even 20 years, it looks like nothing much is happening, then it takes off. That is exponential growth, and it takes time for it to work, but when it kicks in, it really kicks in.
But here is the most important thing to notice about this graph:
- ALL THE PART IN GREEN WAS MONEY THEY DID NOT CONTRIBUTE. The green part is what they earned through investment returns and compounding. This person only contributed the part in blue, which is just a small fraction of that $1 million total.
The part in green was money that they never earned, that never came out of a paycheck, that they never worked even five minutes for—except of course for the five minutes it took them to set up an automatic monthly contribution to their retirement account.
Letting their money earn money is how rich people get rich! And the stone cold truth is that without that green part it is almost impossible for a normal person to save the large quantity of money that is needed for retirement.
But I don’t have 45 years to invest!
Okay, yes I understand that not everyone reading this is 20 and will have 45 years until they turn 65.
Two things …
First of all, you don’t sell all of your investments the day you retire. You will only sell whatever you need each month to live on. So if you are 40, and you think you will live to 85, you actually DO still have 45 years. Your chart will not look like the one above because you will start taking money out, but the remainder can still grow.
Secondly, starting later just means you will have to contribute more than $160 per month, simple as that.
Okay, you have to contribute more, but how much more?
If you want to retire at age 65 with $1 million the graphic below tells you how much you need to be investing each month based on the age that you start. As you can see it jumps up quite a bit as you get older. That is because, as we saw in the first image, the biggest growth happens in the later years.
A key thing to remember: if your employer matches part of your contribution, that also counts. For example, if you are starting at age 35 and your employer does a 1:1 match of your contribution, instead of contributing $588 per month you only have to contribute $294 per month because your employer will contribute the other half.
Having a job where your employer matches at least part of your retirement savings is a huge help in being able to retire. In fact, it can really be a game-changer in terms of helping people get ready for retirement.
Is $1 million really what I need in order to retire?
The answer is … it depends. It depends on your lifestyle, how long you have until retirement since inflation affects what you will need, and many other factors.
That being said, one rule of thumb for retirement is that you can safely withdraw 4% of your investments each year. This is called the “4% rule.” Personally I think it is too conservative, however based on that with $1 million in retirement savings you could withdraw $40,000 per year, or about $3,300 per month. Most of us will also get Social Security. If we assume that will be $1,700 per month that would give us about $5,000 per month to live on.
Is that enough for you? That is a great question. In my coaching sessions we go through a retirement calculator that takes into account your lifestyle, how much you are contributing, investment returns, Social Security, inflation, and your time until retirement. This helps my clients get a better understanding of where they stand when it comes to retirement.
If you want to try this on your own, there are lots of online retirement calculators out there, or you can speak to someone at the company that manages your retirement account.
If you want a more detailed look at retirement you should talk to a licensed financial advisor or a certified financial planner.
You mentioned “compounding,” but what is that actually?
Compounding is when your interest makes interest!
For example, if you put $100 in an account that gets a 10% return, in one year you will have $110. If you leave it there at the end of the second year you won’t have $120, you will have $121 because the $10 from the first year is now also earning 10%.
It doesn’t sound like much, but compounding operates with exponential growth which means that with time those little additions turn into crazy results.
One more image—how Warren Buffett got rich.
Right now, in 2024, Warren Buffett is the 6th richest man in the world, with an estimated net worth of $135 billion. But as you will notice in the chart below, almost all of that came AFTER age 60.
Warren Buffett is a good investor, but the real secret to his astounding wealth is that he has had 73 years for compounding growth to work its magic.
If the person in my initial image graphic invested $160 per month for 73 years (and didn’t need to take any out to live on) they would end up with $12 million—without even being Warren Buffett!
What does this mean for me?
The point of all this is that investing is a long game, and if you want to win this game you need to start as early as possible, be consistent with your contributions, and not get frustrated and take the money out because it seems like it’s going too slow.
Patience and consistency is what will allow you to harness the awesome power of compounding for your own financial future.
It is also important to realize that just putting money in a savings account is not going to get you there. Without the power of compounding, it is very difficult for the average person to save enough for retirement.
As a financial coach I talk with clients about issues like these all the time. We do an in-depth dive into their finances and tackle everything from debt to budgeting to planning for the future. No matter where you are financially, we will come up with a plan that will put you in control of your finances, and on the path to whatever you want your future to be.
If this sounds like something you could use, I offer a free 30-minute initial video-call and affordable rates. My coaching is over video calls, and I do not sell financial products. Schedule your free initial consultation today and let’s talk!
_______
PLEASE NOTE: I am not a Financial Advisor and I do NOT give investment advice. Everything in this article is for educational purposes only and should not be taken as investment advice.
