Thursday, April 14, 2011

Proof That Compounding Works

When thinking about investments, it never ceases to amaze me at how effective compounding investment returns are. As they say, the proof is in the pudding, and by using a simple financial calculator, it's easy to show how beneficial saving and compounding actually is.

One of the things I often hear from young investors - Gen Y in particular - is that they feel that investing for retirement is something that can be put off since it's so far away. I don't like this line of thinking at all because it's self defeating: we save and invest not to retire at an old age, but to have enough of a nest egg built up to retire whenever we want!

Even worse, investors tell me that $100 saved here and there or their small $1,000 savings today won't amount to much so it's not worth investing until they start their careers. This is even worse thinking! Here's proof: If you invest $1,000 in an index fund, assuming a 7% average return and never touch it for 40 years you will wind up with $14,974 due to investment compounding. If the market gets cooking and long-term returns average 10%, you will wind up with $45,259.

Now just imagine what would happen with each additional dollar saved!

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