If you start saving early in life, you’ll have an advantage over those who start later. That's because when you save even small amounts early, you are putting a very important financial concept to work for you: compounding interest.
When you put away money in savings, the initial amount you save is the principal. The principal earns interest, which then is added to the original principal. This greater amount (principal plus interest) again earns interest, and so on—now you are earning interest on your interest as well as on your original principal. This process is called “compounding,” and its effect is like magic when you let it work for you over time.
Here is a dramatic example of why it pays to get an early start:
At age 22, Alletta starts putting $1,000 a year in a tax-deferred individual retirement account (IRA). Tax-deferred means the earnings and the principal aren't taxed until the money is withdrawn, usually years later. Alletta stops putting money in the IRA after 10 years, at age 32, but leaves her money in place so it will grow through compounding until she reaches retirement age.
Her twin brother, Cory, doesn't start his IRA until age 30. But once he starts, he puts $1,000 in it every year for 35 years, until he reaches retirement age at 65.
Alletta and Cory both earn 9 percent annually on their IRAs. Who has the most money accumulated in his or her IRA for retirement at age 65? Look at the chart below—you may be surprised!
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Alletta's IRA
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Cory's IRA
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Interest rate (annual)
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9%
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9%
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Number of years of contributions
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10
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35
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Amount contributed
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$1,000 per year for 10 years (or $10,000)
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$1,000 per year for 35 years (or $35,000)
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Value at age 65
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$261,047
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$215,711
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This example illustrates how starting to save for retirement earlier in life pays off in the future. Consider talking with a parent or friend about beginning a retirement savings account, and get the ball rolling now so that you can enjoy the benefits of compounding interest in the future.