Save Now, Party Later: Your Youth is Your Super Power and the Voodoo Magic of Compound Returns
Do you understand how powerful your youth is? And no, I am not referring to the Long Islands bought for you at bars and your adorable pussy (yeah I said it). I am talking about something of far more gravity than your unfair abundance of collagen or capacity to evade hangovers (can you tell I’m jealous?). I am talking about the power of your youth to achieve retirement savings that could not be matched by an older person who puts in similar (or even significantly more) effort.
The magical force that I speak of is the power of compound returns. (Also known as compound interest, it’s the same shit.) That’s right, feed your investment portfolio a simple elixir that will make it grow bigger and faster and go farther in retirement; a potion sourced straight from the Fountain of (Your Own) Youth. So if you—my beautiful, blooming, witchy reader—are a) interested in harnessing the indubitable charms of your youth and b) like EASY MONEY, please read on.
Compounding returns is the phenomena of earning a profit on not only the moola YOU invest, but on all previous profits. Said another way, your money makes you money, and that money makes you MORE money, which makes you EVEN MORE MONEY. And the more time you give the process to repeat over and over and over, the better!
To understand, it helps to compare simple interest to compound interest. Here’s simple interest, like is paid on a bond or a CD. You sign up for a stated rate of interest, and that’s pretty much what you get.
In this example, you make exactly $100 each year. The math is straightforward; there is no magic here. (Please understand that there is no investment out there that pays 10% simple interest. It just makes for easy math.)
Compare this to compound returns:
Notice that each year you’re invested, the total amount—both the principal and the profit—are reinvested. Each year, you make more in profit than the previous year, even though you contributed NO additional money of your own!
$31!! YEEHAAAAWW!! J-fucking-k. Exactly no one is getting excited about an extra $31 dollars. That buys like, two juices that taste like earth in San Francisco. And it’s true; the first few years, compound returns are not very exciting. It’s slow. It may even seem like the spell isn’t working. But it is. You know how obsessively watching water boil won’t make it boil any faster? Exactly. And with compound returns, it takes 30+ years for the sorcery to really set in.
Yes, thirty and forty years is a long-ass time. And not everyone has it. But you do!
To understand this, it’s best to look at a graph. Here’s what $5,000 invested at a 10% compounding rate of return over 40 years looks like:
You want to be invested for long enough that you make like a rodeo cowgirl and ride that exponential growth curve as it turns vertical. Check out the numbers: The majority of the returns came between years 30 and 40; the last ten years created $27,000 of the $45,000. Said another way, 60% of the returns came in the last 25% of time!
THIS IS WHY YOU NEED TO INVEST. NOW. Even small amounts make a huge difference when we’re dealing with the voodoo magic that is compound returns + time. And how do you do that? Primarily by investing in the stock market. The stock market has historically returned about a 10% compounded rate of return over time, though we should probably downgrade our expectations. But even if the stock market only returns 6% or 7% annually moving forward, your returns are still compounding. (How does one invest in the stock market? Consider using a simple index fund strategy.)
The following example floats around everywhere because it’s damn telling. It’s worth the re-visit: Imagine two investors, one that starts early and one that starts a lil’ later. The first friend started saving $5,000 per year at age 21 and stops at 35. The second friend starts saving and investing at age 35 and contributes $5,000 a year until she is 65 years old.
By age 65, Investor One is worth almost one million dollars. This assumes that she added no money to her account after 35, but continued to invest the money at a 7% annual rate of compound returns. #Kween #BadGranny
Have you seen the *official* #BadGranny #SaveNowPartyLater video? Do #FutureYou a favor and check it out!
Investor Two ends up with a retirement account worth about $500,000. She’s getting the same 7% growth rate as her friend who started earlier, saves twice of much of her own money, and ends up with about half of what her friend has.
The total contributions for our Younger Investor were just $75,000 but grew to almost $1 million. Older Investor saved $155,000 of her own dollars and hers grew to $500K. (Which is still pretty good, TBH. So no matter your age, START.)
Here’s how the numbers shake out*:
Finance writers since the beginning of time (the nineties) have used versions of this story in an attempt to convince young people to invest, even if it’s only small amounts. So, don’t take it from me, take it from literally everyone:
If you don’t start when you’re young, you’re leaving easy money on the table. It’s so tempting to get caught in the mental trap of thinking of saving as this kind of crushing austerity, the Supreme Destroyer of All Things #YOLO, but frankly, this is short-sighted and unfair to your Future Self, who wants you to consider her needs too. The tough reality is that saving enough for retirement (read: 30+ years with NO JOB and NO INCOME) is supremely difficult. We all need ALL of the help we can get, and that means unabashedly tapping into the power of our youth. Unleash the magic, doggies!
This post is the third in my Save Now, Party Later series, encouraging young women to take control of their future freedom and to remember our Futures Selves when creating our own money priorities. Read the first two of the series:
*It is important to understand how the stock market works. The stock market is never up 10% each year, it is an average over long periods of time. While the outcomes that you see here are plausible, this is NOT what the experience will actually feel like. The stock market is volatile. Really let that sink in. The stock market is up some years, sometimes 20% or 30%. Other years, it is down. In 2008-2009, the stock market was down 50%. People freaked the fuck out. But guess what? It came back, and with a vengeance. Even WITH a 50% down year, the average is still 10%. The lesson here? Stay invested throughout all market cycles, even if it feels wrong. You need to be invested for a long enough time to achieve the average, which means going through all the highs and lows of the stock market (and highs and lows again). This takes decades.