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Time on Your Side: The Power of Compounding


When it comes to your retirement savings, there’s some truth to the saying, “Time is money,” and you can find it in an investment concept called compounding. While choosing the right investments is very important, don’t overlook the impact that the compounding of interest can have on your account value over time.  The earlier you begin to save for retirement, the sooner you will be able to leverage the power of compounding interest and its potential impact on the size of your retirement account.

JUMP-START YOUR SAVINGS

The sooner you start to save for retirement, the better. No matter how old you are today, the longer your money is invested, the greater the chance it has to grow. Because of the power of compounding, the money you save will generate investment earnings in your retirement account, and those earnings will also generate earnings, and so on. Call it the snowball effect.

Let’s look at an example that shows how compounding can put your money to work for you.


Compounding Image

Anna starts saving in her employer retirement plan at age 25, putting away $150 per month for 15 years, until she reaches age 40. She contributes nothing for the next 27 years.

Compounding Image 2 

Bob doesn’t start saving in his employer retirement plan until he’s 40. He saves $150 per month for 27 years, until he reaches age 67.

 

 

What will their retirement accounts look like when they’re both age 67?


Compounding Chart

Notice that Anna saved for only 15 years and contributed a total of only $27,000. Yet, her balance is higher than Bob’s, with most of the increase in her account balance coming from investment earnings on her savings.

Starting later, Bob contributed almost twice the amount that Anna contributed. And even though he saved for almost twice as many years, his ending balance was $100,000 less than Anna’s.

Anna’s strategy took advantage of the power of time, which can be a very effective multiplier when it comes to saving and investing.



WHY WAITING TO SAVE DOESN'T PAY

Thanks to inflation, we know that prices of goods and services will be higher in the future than they are today. Although a 3% inflation rate might not sound like much, at that level, prices will double every 23 years. If you’re 40 years from retirement, a new car that costs $35,000 today will cost more than $114,000 by the time you retire.   

Consider, too, that with rising life expectancies, your retirement might last longer than you think. The average 65-year-old man today is expected to live to 84 years of age. Women are likely to live even longer (the average life expectancy for a 65-year-old woman today is almost 87). Keep in mind, those are just averages. One out of ten 65-year-olds today will live past age 95.** Your retirement, therefore, might last 20 or 30 years if you stop working at a typical retirement age. Want to retire early? Then your retirement might last longer than your career!

The future is uncertain. But the more prepared you are financially, the more control you’ll have over when you can stop working and how you will get to spend your time once you do.

START SAVING NOW

Why wait? Too many people put off getting started, and then find that another year (or five) goes by before they “find the time.”  Enroll today before another day goes by. It’s the smart thing to do and it’s quick and easy. If you’re already in the plan, log in to your account and increase your contribution today.

 


*Bankrate, Compound Interest Calculator – Savings Account Interest Calculator, www.bankrate.com.
**Social Security Administration, Calculators: Life Expectancy, www.ssa.gov.

Compounding refers to the process of earning return in principal plus return that was earned earlier. All investments are subject to risk.

The examples are for illustrative purposes to demonstrate the effects of compounding only. They are not intended to reflect the actual performance of any specific investment. Individual experience will likely vary.

The information provided is not written or intended as specific tax or legal advice. MassMutual, its subsidiaries, employees and representatives are not authorized to give tax or legal advice. Individuals are encouraged to see advice from their own tax or legal counsel.

© 2018 Massachusetts Mutual Life Insurance Company (MassMutual), Springfield, MA 01111-0001.  All rights reserved. www.massmutual.com.

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