Compound Interest is one of the most amazing things in this world and is the reason that I got behind investing in the first place. While you might understand compound interest, it’s hard to really get the full impact until you see the math – so let’s check out these 5 insane compound interest examples!
Value of Starting Early
Personally, this was the thing that really got me started in investing. When I was first got started with my investing journey, it all started from a place where I felt like I was constantly in the rat race. Not necessarily living paycheck to paycheck, but always stressing about money, having to constantly budget crunch and try to find a way to make the numbers work, and just being overwhelmed about the future.
Quite simply, I felt like I could never get ahead. I started looking anywhere and everywhere to try to find a way to get ahead and life and I came across this compound interest example:
If you invest a set amount of money from ages 22 – 30, you would have more money than if you invested that exact same amount from ages 30 – 60. Don’t believe it? Check out the math:
As you can see, by investing $1000 from ages 22 – 30, at an 8% compound annual growth rate (CAGR) you would end up with $135,710 at age 60. If you invested that same $1000 from ages 30 – 60, you would have $133,213 at age 60.
The actual dollar amount and the return is irrelevant in this case as long as it’s the same for both examples, the math will hold true. This is all about mindset.
The way to get ahead is to start investing as early as humanly possible. In the first example, you’re only investing a total of $9000, but in the second example, you’re investing $31,000! That is a huge discrepancy between the two options and it’s all about simply just starting early.
The earlier that you can begin, the better off you’ll be. To me, that was truly the foundation of my investing and personal finance journey. I knew that while I was really trying to get ahead in the short-term, if I could squeeze out any extra money at all and invest it, I was going to be so much better in the future. The analogy that I have for it is like buying in bulk:
If you’re buying tooth paste at the grocery store (or on Amazon if you want to save money!), would you rather buy a tube of toothpaste for $5 or a 2-pack for $9? I would always buy the 2-pack because if I was to buy a tube this week and then another tube next week, I’d be spending $10. So, by buying it now, I am saving $1.
Yes, I am taking the hit on the front end and now I must find a way to cut my spending by $4 in the immediate future, but I will be better in the long-term. Investing is the exact same.
Try to do anything that you can to cut your expenses now and just take it on the chin for the short-term – you will be way better off in the long run!
Value of a Side Hustle, Even if Only for the Short-Term
DO NOT underestimate the value of a side hustle. This doesn’t have to be you going out and making insane amounts of money and getting another full-time job by any means, but just anything to bring in an extra little bit of cash.
In the previous example, I talked about how I needed to find a way to create a bigger surplus of money now and then save it because every day that I waited to invest, I was losing money. Well, I accomplished this not only through budgeting and cutting my expenses, but also through a side hustle.
Personally, I invest 100% of my side hustle money because I was living just fine without it, so why would I need to spend it? Instead, every penny that I can invest is going to pay dividends (pun intended) when I want to retire early…hopefully!
Below, I show a few different examples to really prove just how effective a side hustle can be. I have three different time periods ranging from 1 – 3 years, and then I show three different income amounts from $100/month – $300/month. After you have stopped doing that side hustle, the money will just sit there and keep earning the 8% CAGR that I am assuming (stock market average since 1950 is 11%!).
Take a look how dramatic this impact can be:
As you can see, by earning only $100/month for 1 year, and then letting it sit for, let’s say, 43 years, you would have nearly $33K! I picked 43 years because it is most likely that someone younger will have a side hustle since they simply have less obligations, so if you’re right out of college at age 22, then 43 years puts you at the normal age of 65 for retirement. But it’s not only for younger people!
If you’re a bit older, why not look for something with a bit higher income and try to sustain it for longer? Let’s say, $200/month for 2 years. In 30 years, you would have nearly $47K!
Or, if you’re a super go-getter, $300/month for 3 years gets you nearly $101K in 30 years! If you’re that same recent graduate from my first example, after 43 years your $300/month would be nearly $320K! Holy Crap!
The thing is, a small change now can have a HUGE impact later on. That’s why I love side hustles. A small amount of income now, when invested, can be such a life changer in the future. Can you imagine an extra $320K at retirement? That’s the difference of being able to retire multiple years earlier or not.
To me, that’s the definition of live changing.
Coffee a Day!
Please, do not crucify me for this example. I know that some people get so mad about the “if you only eat nothing forever and invest it all at a billion percent return then you can retire tomorrow” type of examples, but this is admittedly all about the mindset that someone might have.
I am a huge fan of Ramit Sethi and one thing that he says, that I just love, is:
“Spend extravagantly on the things you love, and cut costs mercilessly on the things you don’t.”
A $3 coffee might not seem like much, but it can really add up very quickly. Below I show the cost if you were to buy a $3 coffee anywhere from 1 – 7 days/week, and what the true cost would be vs. the opportunity cost!
If you were to buy a $3 coffee for every workday, for the next 30 years, if would cost you $23,400. While that is a ton of money in itself, the opportunity cost would’ve been nearly $95K! If you had just taken that same $3/day and invested it at that same 8% return, you would’ve had that $95K that I am referencing.
Like I said with Ramit’s quote – if coffee is super important to you, keep getting it. All that I am saying is that you likely are spending money on things that aren’t important to you where you can use the same exact logic. Maybe it’s eating out for lunch every day, buying clothes that you don’t really care about, having cable – anything!
Try to take a minimalist mindset about what you actually do and do not care about and cut the things you don’t. A small change today has a huge impact later in life!
Not Maxing Out Your 401k Match
This is the biggest mistake that anyone can make with a 401k and it has an insane cost to it. You might think that the impact to not maxing it out is simply the match, right?
For instance, if the company match is 1:1, meaning for every $1 you put into your 401k the company will also put in, up to 6%, then the amount you’re losing is simply whatever you don’t match, right?
Oh boy – you are so wrong!
Remember in the first example how I talked about how important it is to start early in your investing journey? The same logic applies here!
If you made $50K/year and had a 1:1 match up to 6% and you actually only put in 4%, therefore leaving 2% on the table, you would have $1,119,124 in 40 years – not too shabby! But if you had simply just put in that extra 2%, you would’ve had $1,678,686!
So, that extra 2% that you chose not to put in your 401k, which is $1000 total per year, or $38/paycheck, cost you nearly $560K at your retirement. You saved $40K in total throughout your 40-year career by not investing that extra 2% and it cost you $560K.
Was it worth it?
That question is so rhetorical that I’m not even going to answer it.
Max out your 401K match, no matter what. Plain and simple.
Investing for Your Kids
This is one of my favorite ones that not many people talk about or really even think about. Sure, you might be saying, “I know, Andy. I have a 529 for their education” but that’s not what I mean!
Let’s take a step back and talk about a couple things – why are you even investing in the first place?
Maybe you want to retire early or you want to simply just get ahead. Maybe you want to be able to not worry about money and it’s simply about the stress. Maybe you don’t know the future and want to have money to visit your family if they don’t live near you anymore…I mean, kids do grow up, get jobs and move, after all.
If I had to summarize my reason for investing in one word it would be “family”.
When I get older, I want my wife and myself to have the ability to retire early if we want to spend more time with family.
I want to get a great head start on our retirement savings so that we don’t have to make the decision in the future of going on a vacation or saving more money. I want to be able to afford a lake house if we want one which is a dream of ours. In short – money gives us more opportunities to do things with family and make all of our lives better.
At the same time, if someone told me that either I could retire early or my son could, I would pick for my son, and I think that any parent would do the exact same thing. I’d rather work more to give him the opportunity to spend time with his family. But how do you do that?
Well, remember how I talked about the importance of investing early? What if we started 65 years early?
“Andy – what? That’s insane!”
But is it? What if I started investing for my son’s retirement…RIGHT NOW! It might seem crazy, but I don’t just want my family to be setup for success – I want my entire family tree, for hundreds of years to come, to be setup for success.
I am going to do that for investing for my son’s retirement.
I’m not investing a ton for him, in fact I am only investing $50/month because I still want to make sure that my wife and I are hitting our goals as well, but even $50/month can go a very long way.
As you can see, by investing only $50/month at an 8% CAGR, our son would have nearly $1.2 MILLION when he went to retire! Of course, there is going to be some impact due to inflation, but isn’t it insane that our son can be provided this by simply investing $50/month?
A total of $39K is invested and it generates $1.2 million…wow.
Maybe you can afford more, and if so, do it! Maybe you can only afford $10/month, and if so, do that! Even $10/month is worth $240K. Do you wish you had $240K right now from your parents? I sure do.
Investing in your kids’ retirement is the #1 way to provide for your family in my opinion. Doing so is going to allow them so many opportunities, and hopefully #1 is for them to invest in their kids’ future.
You see – we’re not just investing in our son. We’re creating a process for our entire family to benefit. It’s so insanely simple if you simply just understand the power of compound interest.
Hopefully by now you are SUPER motivated to start investing or maybe you start investing even more. Investing isn’t hard as long as you maintain a margin of safety and are a student of looking for companies that are undervalued to their intrinsic value.
Did that sound like gibberish to you? Don’t worry – we’re here to help!