By implementing sound principles of saving and investing, average people – with average salaries and expenses – can build wealth. For most people, building wealth may be a lot like cooking stew in a crock pot. Two ingredients are required: discipline and time.
- Time harnesses the power of compound interest. Simply put, compound interest is the money gained by leaving your dollars invested. It’s interest earned on the interest. Say, for example, you put $1,000 in an investment earning 5% annually. After the first year, your account balance will have grown to $1,050. Leave your money invested, and by the end of the following year you’ll have $1,102.50. You make more money the second year because you also earn interest ($2.50) on the first year’s interest ($50).
- The sooner you start investing, the less you’ll need to save. Take, for example, two fellows named Tom and Jerry. Both are 18 years old. Tom paid attention in accounting class and started saving $100 a month. For ten years he contributed to a relatively conservative mutual fund that earned 7% annually. At age 28, Tom lost motivation and stopped saving.
Jerry, on the other hand, was a party animal. For the first ten years after high school, he spent every penny he earned. But at age 28, he got discipline. He started saving $100 each month, the same amount Tom had been saving for ten years.
By age 65, who comes out ahead? Tom is the clear winner with about $230,000; Jerry places second with $210,000. Consider that Tom saved $100 a month for ten years ($12,000) and Jerry saved the same monthly amount for 37 years ($44,400). Why did Tom end up with more money? Because his funds were invested longer. The power of compounding amplified his investment. (By the way, had Tom invested $250 a month from age 18 to 65, he’d have over a million dollars by age 65.)