Stumbled upon yet another article about the extreme power of compounding.
They use the following examples:
Let’s say Olivia saves £100 a month in to her pension from age 21 and stops at 30 - saving no more until she accesses the pot at age 70. We’ll say the pension earns a 7% return each year for this example. Olivia will have £282,325.
Oliver, meanwhile, doesn’t save anything until he is 31 and then saves £100 a month until he is 70. Olivier will have £262,481.
What do you think?
This is right. Amazing thing is that whenever’s I tell people about this, they don’t believe me. Everyone says he will start investing later when he’ll earn more.
Yes, the human brain is not equipped to grasp compound interest.
In the same category, if i give you 10 seconds to choose between $700’000 now (proposition A), or $0.01 doubled every day for one month (30 days, proposition B), most people will choose instinctively A over B, without realizing that B is roughly worth $10 million.
Ironically, what you do in your twenties will have the greater impact for your late ages, and therefore carry the biggest opportunity cost. What’s funny (or dramatic, depending on the observer’s lense) is that the twenties are usually when people start earning money and thus want to finally buy stuff…
Somewhat oversimplified and too optimistic imv. It seems inflation is assumed to be 0% while yearly avg gain is 7% … that seems a bit steep
Interesting. Too bad I just started with 28.
Imagine if I knew all these things with 18.
With a return of 7.18%, the second person will never catch up because the amount earned with interest is higher than the amount that the second person saves.
f(x)=2^(1/x)-1
Gives you the breakeven yearly gain for that to happen for x= number of years.
Here are the breakeven gains for 10 to 15 years advantage:
10 is 7.18%
11 is 6.5%
12 is 5.95%
13 is 5.48%
14 is 5.08%
15 is 4.74%
Education.
Let’s assume both Oliver and Olivia attend the same university, for the same degree, graduating with same grades and same employability (all things equal).
Hopefully Oliver focuses on his education and career in his 20s, rather than his savings.
If he manages to finish school or university just one semester earlier than Olivia (which might very well be possible by saving less) and enter the workforce a few, say six months earlier, he should, all other things equal, be able to quickly save a few thousands more than Olivia within half a year. A couple thousands more at 31 should quite make up for his non-saving in his 20s.
Also, keep in mind that one should discount the value of future savings contributions by interest or inflation rate as well. In layman’s terms: saving £100 at 70 years of age, 50 years in the future “hurts less” than saving £100 today. The present value of £100 in 50 years at a(n arbitrarily chosen ECB inflation target of) 2% rate of inflation is just approx. £37 in today’s GBP.
Though it is quite possible - if not likely - that we’re going to see periods of higher inflation within a span of 50 years. So the present value might be considerably lower. For instance, actually looking back at the last 50 years inflation in the Pound Sterling, the present value of today’s £100 (in 2019) was just slightly more than £6 (£6.13) in 1969.
A lot might then come down to sequence of returns. Even more so, if you’re saving now for 10 years and then wait another 40 years before withdrawal.
EDIT: Same web site as above gives an average rate of inflation of 5.75% over the last 50 years for the Pound Sterling.
what do i think?
get you excel sheet ready and play abit. you quickly get a feeling for it.
yes, compounding is powerful. but how powerful exactly? calculate it yourself!
Nice example indeed. I would argue that the best time to start saving is: TODAY!