Leveraging Compound Interest to Grow Your Nest Egg
A few weeks ago, my wife Linnea and I were having a conversation regarding the investment account we set up for our daughter the day she was born. While it is natural for me to check the account on a regular basis, Linnea prefers a big picture update each year. When I pulled up the account, I was excited to show her the growth over the first 3 years.
During my progress update with Linnea, I enthusiastically went into detail about each investment. Since she has less of an interest in all the details, she followed up with, “Mike, what does all of this mean? If we keep putting the same amount of money into her account each month, how much will she have when she is an adult?”
I honestly had no idea. I had no idea because I had not stopped to consider this before. Our goal was never a specific dollar amount but rather to save continuously so our daughter would have money for whatever needs may arise in the future. To answer her question, I took out my financial planning calculator. Yes, I have a special calculator for situations just like this! It took me less than a minute to calculate the results. And it was eye opening. Assuming we average a 10% rate of return annually, we will have saved more than 1.5 million dollars for our daughter by the time she turns 40. So how is that possible?
Compounding interest. Many of us are aware of compounding interest and the power it can have over time. However, we often see the topic presented in a way that is theoretical in nature and unrelatable in our own life. The general assumption is that saving 1.5 million dollars would be complicated and perhaps overwhelming for the average family. However, if you have the cash flow to do it and you are diligent, the plan is simple. $250 per month (about $63 a week) into equity investments starting the day your child is born. If you do not withdraw from this account prior to their age 40 and earn an average of 10% annually (10% is approximately the average annualized total return for the S&P 500 over the past 90 years), then the potential is a 1.5-million-dollar account value.
If a monthly contribution is difficult from a cash flow perspective, another option for families is to save a lump sum amount. A child’s birthday, holidays or special events are often when family members gift money for savings. The monetary gifts can help offset the amount you would contribute with the end goal being equal to $3,000 per year. Another idea would be to use a portion of an annual bonus or tax refund.
What about for those families who are simply not able to afford $250 per month or $3,000 per year because cash flow is tight, or they have more than one child/grandchild? That could add up quickly!
For those individuals, I wanted to provide a simple table showing how much of a difference a small monthly amount can make for your child’s investments:
In saying all this, I hope the conversation that my wife and I stumbled upon is an encouragement to you and gives you a practical example of how consistently saving money can be an incredible foundation for your children and grandchildren.
