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Compounding and the Potential Benefits of Starting Early

Why should you consider starting to invest today rather than tomorrow?

The power of time

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The sooner you begin saving, the better your chance of reaching your goals.

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Why is time of the essence? The sooner you begin saving toward a goal—whether it’s helping to pay for a child’s or grandchild’s education, having enough to retire comfortably, making a large purchase, or doing something else—the better your chance of reaching it. And, this can be even more powerful if you invest in a tax-advantaged account like an IRA or qualified employer sponsored retirement plan (QRP) such as a 401(k), 403(b) or governmental 457(b). Consider this example that shows how starting sooner rather than later can help your money work harder for you:

Let’s assume Investor A invested $1,000 per year for 10 years beginning at age 30 and reinvested any potential earning (interest, dividends) back into his account. Investor B also invested the same amount per year, earned an identical rate of return, and reinvested her returns; however, she waited until age 45 to start with the strategy and continued with it for twice as long (20 years). Assuming a hypothetical 6% annual return, here’s a comparison of the two scenarios:

Investor AInvestor B
Total Invested$10,000$20,000
Hypothetical annual return6%6%
Account value at age 65$59,964$38,993

Even though Investor A saved half as much as Investor B, Investor A had more money at the time of retirement, all because of starting earlier and the power of compounding interest. The extra years of compounding boosted his bottom line. Investor B will now have to save more if she wants to catch up. This is the potential cost of waiting, a cost that quickly adds up. It doesn’t matter what age you are—you’ll have more time on your side if you start saving today.

Next steps

  • Work with your financial advisor to determine your goals and start saving as soon as possible
  • Remember to reinvest your returns back into your account so you can receive earnings both on them and the amount you invest
  • Consider using tax-advantaged accounts for education (Coverdell Education Savings Accounts and 529 plan accounts) and retirement saving [Traditional and Roth IRAs and employer-sponsored qualified retirement plans (QRPs) such as 401(k), 403(b) and governmental 457 (b) ], which can enhance the power of tax-deferred compounding

Wells Fargo Advisors does not provide tax or legal advice.