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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 fixed rate of return and annual compounding, here’s a comparison of the two scenarios:

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

The growth of the assets is before tax and portions of distributions from the account will be taxed at an ordinary income rate at the time of withdrawal. The chart does not represent the returns of any particular investment and should be not be used to predict or project performance. There is no guarantee you will earn 6% on investments and your account value may fluctuate over time. It assumes all earnings are reinvested and does not include transaction costs, fees, or expenses associated with the account or any individual investment made in the account.

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.