The Magic of Compounding
With this neat trick, small contributions to a retirement account can grow into a big nest egg over time.
It looks like 2008 is shaping up as the year Americans are getting serious about saving.
In a survey by the American Institute of Certified Public Accountants, 25% of U.S. adults said they are spending smarter this year, or not spending as much, to save money -- up from just 2% in 2007. A survey by HSBC Direct found that 81% of those who responded want to increase the amount they save in 2008.
What really fires people up, according to a study by Wachovia and the Consumer Federation of America, is a graphic illustration of the real secret to successful saving: Thanks to the magic of compound interest, even small amounts of money can grow into big piles of cash over time.
Sign up for Kiplinger’s Free E-Newsletters
Profit and prosper with the best of expert advice on investing, taxes, retirement, personal finance and more - straight to your e-mail.
Profit and prosper with the best of expert advice - straight to your e-mail.
For an eye-opening example, consider two young people, Kevin and Kelsey. At age 20, Kevin begins contributing $3,000 per year to an IRA. He continues for ten years and then stops, letting his money sit in the account.
Meanwhile, Kelsey delays saving until age 30, when she starts contributing $3,000 every year to an IRA. Who will have more money at retirement?
Abracadabra, the answer is Kevin. Even though he stopped contributing after ten years, his retirement fund will grow to $1.5 million, assuming a 10% annual return (the historical stock-market average).
In contrast, Kelsey, who saved $3,000 a year until retirement but started ten years later, will amass a little more than $900 000. To run your own numbers, see our How much will my savings be worth? calculator. (For a calculator geared toward younger children, go to the Saving Rocks page at www.orangekids.com.)
Of course, final totals will differ depending on when you start, how much you contribute and how much you earn. But all other things being equal, the results are always the same: The earliest bird winds up with the fattest worm.
It's easy to capitalize on the magic of compounding. You can set up an automatic transfer to a bank or investment account or to your company's retirement plan (see Ten Sneaky Saving Strategies).
To jump-start saving among its young customers, Wachovia has introduced its Way2Save account. Set up a Wachovia checking account and you can automatically transfer up to $100 each month to a savings account that pays 5% for the first year, and 2% in the second and third years.
Plus, each time you pay a bill online or use your Wachovia check card, $1 will be transferred from your checking to your savings account. And there's an annual savings bonus based on your account balance.
Wachovia estimates the average customer should accumulate $2,000 over three years -- a good start toward building an emergency fund or seeding that IRA.
Coming: Saving tips for younger children.
Get Kiplinger Today newsletter — free
Profit and prosper with the best of Kiplinger's advice on investing, taxes, retirement, personal finance and much more. Delivered daily. Enter your email in the box and click Sign Me Up.
Janet Bodnar is editor-at-large of Kiplinger's Personal Finance, a position she assumed after retiring as editor of the magazine after eight years at the helm. She is a nationally recognized expert on the subjects of women and money, children's and family finances, and financial literacy. She is the author of two books, Money Smart Women and Raising Money Smart Kids. As editor-at-large, she writes two popular columns for Kiplinger, "Money Smart Women" and "Living in Retirement." Bodnar is a graduate of St. Bonaventure University and is a member of its Board of Trustees. She received her master's degree from Columbia University, where she was also a Knight-Bagehot Fellow in Business and Economics Journalism.
-
Winners and Losers of Fed Rate Cuts
Navigating interest-rate changes can seem daunting, but these areas of the fixed-income market could perform better (or worse) than others.
By Jeffrey R. Kosnett Published
-
What You Should Know About Spousal IRAs
Without spousal IRAs, you would need an earned income to contribute to your retirement account.
By Sandra Block Published
-
Smart Savings Tips for New Grads
Financial Planning You got the degree. But do you have a sound savings plan for life beyond college?
By Janet Bodnar Published
-
Personal Finance Advice for College Students
Budgeting Here's what students heading off to school this fall need to know about managing money.
By Janet Bodnar Published
-
Saving for College Vs. Retirement
savings Which is more important? And how much should you save for each?
By Janet Bodnar Published
-
Roth IRAs for College Savings?
savings Yes, you can use these accounts to pay for college. Learn the rules and find out if this savings strategy makes sense for you.
By Janet Bodnar Published
-
Kid IRA Q&A
savings Find out if your child must file a tax return to open an IRA, what the best investments are for the account and whether an IRA affects college financial aid.
By Janet Bodnar Published
-
Can Your Child Open a Roth IRA?
Roth IRAs Find out if your kid qualifies for this tax-sheltered savings plan. Plus, how much to contribute and which companies will open an account for a minor.
By Janet Bodnar Published
-
Roth IRAs and Financial Aid
Paying for College You don't have to report retirement accounts on your FAFSA, but some colleges may include the balances in financial-aid calculations. Plus, answers to other college costs questions.
By Janet Bodnar Published
-
Roth Rules for Kids
savings Opening a Roth IRA for your children is a great idea, but they must have earned income from a job -- allowances don't count.
By Janet Bodnar Published