When it comes to building wealth and securing your financial future, there’s a magical concept that can make all the difference: compounding. And it’s especially potent when you start in your 20s. It’s a concept that should be taught in middle and high school, and sadly many adults don’t understand this powerful concept. Let’s dive deep into compounding, what it means, and why beginning to save in your 20s is the smartest financial move you can make.
What is Compounding?
At its core, compounding is the process where your money earns interest or returns, and those earnings generate even more earnings over time. Think of it as a snowball rolling down a hill, gathering more snow and growing larger as it goes. And moving faster and faster, gaining more and more momentum. Your initial investment grows not only on the principal amount but also on the interest or returns it has already earned.
The Power of Time
The key to compounding is time. The longer your money is invested, the more opportunities it has to grow through compounding. This is why starting early is crucial. I have several examples of this in my book, Sister, Own Your Finances. Each year, your investment returns get reinvested, and over time, your wealth can grow exponentially. We’ll illustrate this concept with a real-world example to show you just how powerful it can be.
Why Start in Your 20s?
Starting to save and invest in your early 20s might not be the most exciting activity on your to-do list, but it’s undeniably the most rewarding.
Longer Time Horizon: The longer your money is invested, the greater the potential for growth. We’ll show you how time can multiply your wealth.
Lower Risk Tolerance: In your 20s, you can afford to take more risks in your investments. This can potentially lead to higher returns.
Financial Freedom: Starting early gives you a head start on achieving financial freedom and reaching your long-term goals. We’ll discuss the possibilities that open up when you have a substantial nest egg.
Here’s an example that may help you see the appeal of starting young:
Assume you save $100 per month and it is invested with a consistant 6% return, year after year. If you save until age 55… and begin at age 25, you will have a nice $97,798 tucked away. If you wait to begin at age 35, you will have accumulated $45,505. And if you wait until age 45 (when many people hit the panic button), you will only manage to accumulate $16,305.
Let’s look at the 30 years balance of $97.798. Consider you investment over time: $100 times 360 months is $36,000. Yet your balance is $97K. You earned over $61K in interest, nearly double your investment.
Do you see the power? Compounding is like a financial superpower, and it can be your ally when you start saving and investing in your 20s.
