The Multi-Million Dollar Mistake: “I’ll Invest Later”

The Eighth Wonder: Compound Interest

Albert Einstein is often attributed with the quote “compound interest is the 8^th wonder of the world.” I tend to agree. It’s really almost like magic. For those of you who need a quick refresher, compound interest is the idea of exponential growth.

Here’s a simple example:

Suppose you have $100 and can buy an asset that provides you a guaranteed 10% rate of return each year. The first year you’ll make $10, giving you a total of $110 going into the next year. In year two, you once again earn a 10% return but this time it’s 10% of $110 or $11. Then next year is 10% of $121 and so on. Eventually you end up with a growth curve that looks like this:

In just 10 years, you’ve more than doubled your money! At the core of the concept is the idea that your money makes more money. I like to think of my invested dollars as little workers that earn money. That earned money in turn becomes another worker that earns more money. Eventually you’ll have an army of dollars working for you without you needing to lift a finger! Compound interest is the secret sauce to building wealth.

Your Greatest Asset: Time

Time is truly the most valuable asset. It’s the only thing we all want more of but can’t get. No amount of money can buy you more time. Time, however, can get you more money.

If you noticed in the chart above, you probably realized that it’s the later point in time where the growth of the $100 starts taking off. This is because exponential growth is like a snowball, it takes a bit to get going but once it’s large enough it becomes nearly impossible to stop.

Here’s the same chart as above but this time going all the out to 40 years:

Our $100 has grown to just over $4500, 45x our starting amount. Notice how most of the growth occurs in the latter half of the chart. Right around the 30 year mark is what I would call “escape velocity”. The point where things snowball to insane numbers. Imagine instead if we had invested $1000, $10,000, or even $100,000!

This is all fine in theory, but you might be wondering, does something like this even exist in real life?!?

The answer is Yes!!! Well… sort of. Here’s a chart of the S&P 500 over the past 90 years. ¹

The exponential nature of the chart is staggering. Going back to 1928 the S&P 500 was about $17. Today, it’s ~$6000. If you were able to invest way back then you would’ve 350x your money. A few things to note:

• Unlike our toy example this curve doesn’t go up in a straight line. There are some pretty scary drops
• This is not inflation adjusted. Because prices increase over time the chart is a little less impressive than it seems
• The chart is missing dividend reinvestments which would change the numbers quite a bit

I sometimes dream of having a great-great grandparent who was smart enough to invest back then. Alas that wasn’t the case.

As you can see you need time for investing to work in your favor. The earlier you start the better. You will, quite literally, be exponentially better off.

Playing Catch-Up is Hard

To further drive home the importance of investing early, I’d like to illustrate a hypothetical example. The math here can get a little hairy so I’ll spare you the details and just share the results.

Let’s suppose we have 3 people: Alice, Bob, and Charlie. All of whom are 20 years old and would like to retire by age 65. For the sake of the example, we’ll also assume they all make the same amount of money and have the same amount of expenses for their essential needs. We’ll also assume that all 3 people can invest in an asset that gives a 10% guaranteed return.²

Alice, knowing the importance of starting to invest early decides to take $500 out of her paycheck each month to invest. She does this every month until she retires, 45 years later, at age 65. Alice will have contributed, 500 x 45 x 12 or $270,000 of her own money towards her retirement. In the end, Alice will have a nice $5,284,928 to enjoy in her golden years³

Bob decides he wants to buy a fancy sports car and holds off on investing until he’s 30. When he turns 30, Bob begins to invest $500 every month until age 65. This gives him a final balance of $1,914,138 for retirement

Lastly, Charlie decides to use all his money to travel the world and holds off on investing until he’s 40. When he turns 40, Charlie also begins to invest $500 every month until age 65. Charlie’s final retirement fund is $668,945

As you can see there’s a drastic difference in the final balances of these three individuals. All of this is simply because Alice decided to start investing just a bit earlier.

Suppose Bob and Charlie realize in advance that they’re going to be behind and want to have the same retirement balance as Alice at age 65. To “catch-up” to Alice, Bob and Charlie will need to contribute more than $500 a month towards retirement. In order to have the same $5.2 million in retirement, Bob will need to contribute $1,380 a month and Charlie will need to contribute $3,950 a month. Nearly 2.5x and 8x, Alice’s contributions!!

Having to go from contributing $500 a month to $3,950 a month can be near impossible for most peoples’ budgets.

Summary

Although it’s important to strike a balance between living for the now and experiencing your youth, it’s important to see how valuable investing early is for your financial future. Alice didn’t even have to invest much per month to end up with a monstrous retirement balance. A little bit early on goes a long way. If you wait too long, it may be too late.