You always hear the term compound interest when it comes to investing, but what does that really mean?

Compound interest is the interest on savings calculated on both the initial principal and the accumulated interest from previous periods.  What does this really mean?

Let’s look at an example.

If 2 people save $100 a month for retirement, but one starts at 25 and the other at 35, the early saver will have twice as much in their bank account by 65.   Why? Compound Interest!

Tanza Loudenback wrote a great article for Business Insider titled “How much more money you’d have for retirement if you saved $100 a month starting at 25 instead of 35” | Click Here For Article. I thought this article was important to share but here is the quick math.

The above chart shows 2 people saving $100 a month at a 5% compound rate of return.  The blue line is someone who saves $100 per month from age of 25 to 65 (40 years) vs someone who saves $100 per month from age 35 to 65 (30 years).  What you see in this chart is that the individual that saved for an extra 10 years has $162,000 vs. $89,000.  So that is an increase of $73,000 when the younger saver only contributed $12,000 more of his own money. This is because both the principal and interest are making interest during those extra 10 years.

If you haven’t started saving, no worries.  Starting to save now is better than starting tomorrow, next week or never; there is no replacement for time.