Back to the Basics: Time Is Money
Over 60% of Americans start saving for retirement after their 30’s, so why should you, a (possibly-sub) 20-something year old even think about it? Well, hopefully by the end of this article, with the help of ✨compound interest ✨, I’ll convince you that saving for retirement yesterday is one of the best decisions you’ll ever make.
Compound Interest 101
Albert Einstein is often quoted describing compound interest as “the most powerful force in the universe” (though the validity of this is questionable). In any case, once you understand compound interest, you will see why this claim isn’t too far off. ⏳
Here is the equation for Compound Interest:
Let’s break this down:
Principal: This is the initial amount of resources you start with. In our discussions, this is just 💰, but you can apply Compound Interest to anything of value (e.g. houses, chickens, your Instagram followers, etc.)
Interest: Pretty much every place you put your money will have an “interest rate”. Interest rates can be higher or lower for a variety of reasons (e.g. risk, liquidity, etc.), but what it boils down to is just the % of the money you put in that the person holding your money will pay while they use your money for whatever they feel like.
Compound Rate: This is the number of times that you apply the interest to your money in a given period of time. For example, if I offer you an account to hold your cash at a 1% interest rate compounded monthly, then every month, I’ll add to the balance of your account 1% of its current value. Interested in opening an account? 💸
Time: Probably the most important variable of all, this is the time that the account exists. For our previous example, let’s say you kept your money in my account for 2 years before realizing that I was using the money to bet on hamster derbies, then (since the Compound Rate is monthly), you will have let your money sit with me for 24 months.
Whew! Now that we got that out of the way, let’s see why this actually matters when thinking about saving for retirement (and pretty much any financial decision you make, ever).
There are a lot of ways you can save for retirement, and each of them differs in two ways in terms of Compound Interest: Interest and Compound Rate. Compound Rate is not usually something you’ll have much of a choice in (i.e. most Compound Rates are monthly or annually), so let’s compare different retirement accounts compounded annually with varying interest rates.
Regular Savings Account at [Traditional-Bank]
Okay, this is probably the most familiar. You might even have a savings account with one of these. Did you know that an average bank savings account has a 0.06% APY*?
*APY is just the interest rate for an account compounded annually
Let’s say you were skeptical after reading this article, and waited till you were 30 years old to start saving for retirement. To simplify the math, let’s say you make all of your contributions at once: say $1000 per year until you’re 60 = $30K. This is your Principal. Let’s see what the value of your account would be when you turn 60:
So when you’re 60 years old, you’ll have magicked $544.72. Neat, huh?
However, let’s say you’re convinced that saving early is a good thing, and started saving when you were 20 years old. How much would you have at 60? Same principal, same interest rate, would come out to $30,728.49. The following chart shows how much Interest you would make (on top of the $30K principal) starting at 20 vs. 30.
That’s an extra $183.77! That’s over 100 Wendy’s 6 piece chicken nuggets. Same amount, longer time. Not convinced? Read further…
High-Interest Savings Account at [Fancy-Online-Bank]
What if I told you that some banks (that your parents probably haven’t heard of) have savings accounts with ~1.8% APY? That’s what High-Yield savings accounts offer: a much higher-interest option to hold your money than savings accounts at traditional banks.
Why do these exist? One big reason is that these banks (usually online) have lower operational costs (e.g. no physical locations), but they’re also fairly new/less established than your household Big Banks, so in order to compete with the bigger players and get more money into their accounts (which is what banks optimize for), they offer incentives like higher interest rates.
Anyway…let’s go through the same calculations that we did in the previous section to see how much more 💵 we’d have starting at 20 vs. 30.
Total Balance if you start saving @ 30 years old: $51,233.57
Total Balance if you start saving @ 20 years old: $61,239.60
That 10-year difference amounts to over $10,000. You can literally buy diamond-studded jeans for that money. Still not convinced? Read on…
Retirement Investment Account at [Pick-Any-Brokerage]
There are as many different types of Retirement Investment Accounts as there are stars in the universe (not really), and we’ll definitely have articles on the intricacies of IRAs / 401(k)’s in future editions, but suffice to say, the average annual interest rate historically on these types of accounts is 7%.
Let’s see what would happen if we put our savings into a Retirement Investment Account…
Total Balance if you start saving @ 30 years old: $228,367.65
Total Balance if you start saving @ 20 years old: $449,233.74
That 10-year difference amounts to an extra $220,866.09, which is pretty much double what you would’ve made starting at 30 years old. At this point I don’t need a silly metaphor to put an extra $200K in your pocket into perspective 🤑
For a quick and easy way to start growing your money with compound interest, start a high-interest savings account. This is the simplest to manage and gives you an opportunity to begin bucketing your money into “retirement”, as well as preparing you for more interesting/higher return options that we’ll talk about later.
When evaluating your options, there are 2 numbers that’ll vary across accounts: APY and Minimum Balance. The APY doesn’t matter that much because the differences are small and APYs are variable (i.e. change based on outside forces like the Federal Interest Rate). The Minimum Balance is important to keep in mind, just to make sure you have the cash-on-hand to get the advertised APY.
There are a lot of options out there, but we recommend spending no more than 30 minutes researching! Kavya chose Marcus (by Goldman Sachs) because it had the highest interest rate when she opened it, but now it’s on par with pretty much every other high-yield savings account. I chose Betterment Cash Reserve because I use Betterment for investing, and having both accounts through the same service made it easier to manage. Bottom Line: the differences don’t matter that much, so don’t worry about choosing the “perfect” high-yield savings account.
Here’s an article to help you start your search.
There’s still a good deal left to discuss (e.g. the different types of retirement accounts, why you should factor in taxes when thinking about this, etc.), but hopefully, this shows you that it PAYS to start saving early while you’re Young, Not Broke. 😤
Disclaimer: The content on Young, Not Broke is for informational and educational purposes only and should not be construed as professional financial advice. Should you need such advice, consult a licensed financial or tax advisor.