You’re never too young (or young at heart) to begin building an investment portfolio! Actually, investing when young has the potential to produce impactful earnings gains. And that’s because of a concept called compounding.
Like a snowball that grows as it rolls down a hill, compounding gives your money the opportunity to grow, continually reinvesting your investment earnings.
With compounding, the more you invest, the greater opportunity you have to create long-term value. Here’s a quick example:
Let’s say you invest $1,000 at age 20 and don’t add anything to the principal, you just compound earnings for 50 years until you turn 70.
If you take a 7.2% annual rate of return, by age 70, your $1,000 would have grown to $32,000. Not bad.
Now let’s say you take the same approach but delay investing until you’re 30, and that $1,000 has 40 years to grow. Assuming the same annual rate of return of 7.2%, your $1,000 investment will have grown to $16,000. Not nearly as good. In fact, that’s a 50% decrease.
However, if you invest $1,000 at age 20 and contribute an additional $83 a month – or $1,000 a year – until you turn 70 (assuming that same 7.2% annual rate of return), your total savings will reach $465,000. Wow. That’s nearly 15 times more than our first example.
To be clear, these are hypothetical examples and aren’t representative of a specific situation; just using them to illustrate the power of compounding.
In addition to rates of return, and in reality, you need to also consider the deduction of fees and charges inherent to investing. We can talk more about that another time. Needless to say, your results will differ depending on your situation.
Want to know how long it would take for compounding to double an investment? Divide 72 by the annual rate of return. The answer is the approximate number of years it would take to double your investment’s value, assuming a fixed rate of return.
If you earn 9% annually, it would take 72 divided by 9 or 8 years to double the value of your investment. Mind you, this is a rough estimation and not a guaranteed time frame. This quick math can give you an idea of how quickly your savings can grow when compounding is at play.
The advantages of starting to invest while you’re young are undeniable. The power of compounding, the benefits of long-term investing, and the potential for financial freedom all make it clear that investing early is a smart move. So why wait? Your future self will thank you.
If you’re interested in understanding compounding or long-term investing and want help putting together an investment strategy that works best for you, let’s talk!
The rule of 72 is a mathematical concept and does not guarantee investment results nor functions as a predictor of how an investment will perform. It is an approximation of the impact of a targeted rate of return. Investments are subject to fluctuating returns and there is no assurance that any investment will double in value.
This material was prepared in part by LPL Financial, LLC