Lots of people in their 20s miss out on hundreds of thousands of dollars in retirement savings because they “don’t get” the power of compound interest, says Suze Orman, personal finance expert and host of the podcast “Women & Money (and Everyone Smart Enough to Listen).”
“They don’t understand the value of compounding and that the key to their financial independence is their age,” Orman said in a recent interview with the Wall Street Journal. Part of the problem is that younger people think they can catch up on retirement savings when they’re older and making more money, she said.
Building up retirement savings is crucial. Underestimating how much money you’ll need to invest later to catch up, or need in total to retire, could force you to keep working until a later age than you want. In some cases, you may never be able to retire at all.
To illustrate the power of compound interest, Orman used the example of a 25-year-old who puts $100 into an S&P 500 index fund through a Roth IRA, every month until they are 65, assuming an annual interest rate of 12%. That person would retire with roughly $1.2 million in retirement savings, according to CNBC calculations.
However, if they started saving at 35, their total would be just over $350,000. That works out to a difference of about $850,000 lost by beginning to invest just 10 years later.
That’s due to the power of compound interest, the process in which interest is continually earned on both the principal amount plus any accumulated interest, leading to exponential growth over time. Thanks to compounding, the earlier you start making contributions, the more time your money has to grow.
“[Many young people] don’t get that,” said Orman. “They would rather dress cool, go on their TikToks.”
All investments carry a risk that you could lose your money. And an annual return of 12% isn’t widely seen as realistic. Historically, the average annual rate of return for the S&P 500 has been around 10%.
But even with an annual return of…
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