Sacrifice Now; Enjoy Later: The Power of Compound Interest

Document created by austin on May 16, 2016Last modified by amara.mastronardi@socialedgeconsulting.com on Dec 5, 2016
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Everyone likes buying the latest and great things, but lacking the foresight to consider retirement and emergencies can be a costly mistake. Building an emergency and considering retirement at an early age is extremely beneficial for young people because of the safety net that savings provide and because of the power of compound interest, respectively.

 

However, most Americans (of all ages) are not considering either. According to Bankrates.com, about 63% of Americans don't have enough savings to cover a 500 dollar emergency. Additionally, GoBankingRates reports that one in three Americans have no money saved for retirement. From the same study, only 44% of American have more than 10,000 dollars saved for retirement. Most Americans currently aren't thinking about the future.

 

In regards to an emergency fund, it can be beneficial for one to ensure that they can live 3 to 6 months without any income. While this can be a rather daunting goal for college students and recent graduates, that conventional wisdom should not be ignored. At the very least, attempting to save one to two thousand dollars can insure that one won't have to dip into credit card debt (that generally accuse near 20% interest) to cover an emergency.

 

In regards to retirement, young people have an incredible advantage over older Americans: their age. Albert Einstein once said, "Compound interest is the eighth wonder of the world. He who understands it, earns it––he who doesn't––pays it." Following the rule of 72, if I, a 19 year old, saved one dollar that accrued at 7 percent per year, for 50 years, then that dollar would be worth 32 dollars when I retired. Wow! 32 dollars from deciding to save only one. But there is even more good news regarding retirement.

 

Remember those statics about Americans not saving? Well, the US government has taken note of these statics and have passed tax lows that greatly benefit Americans who decide to save and who save correctly. Now, there are many different types of investment accounts (401(k), traditional IRAs, Roth IRAs, etc); but for myself, I plan to save in three different accounts. Currently, I have two of these accounts open and in use: a Roth IRA through WiseBaynan and a generic investment account with Acorns; but once I start a job that offers it, I will also open a 401(k) with my employer. Lets break these investment accounts down:

 

Regarding my Roth IRA, this is my current main retirement account. I invest a fix amount of my income (about 10 percent of my monthly income) and I won't be able to access this money again until I am 59 and a half unless I want to incur a penalty. Now, the money I contribute to this account is tax deductible! This means that I don't pay taxes on the money that I put into this account up to about 5,000 per year. Not only that, but since it is a Roth IRA, I don't pay tax on the income generated from the interest rate! I will only pay taxes from this account once I withdraw money from the account, but Uncle Sam does need his cut to operate. (Note: WiseBaynan, to my current understanding, is free for basic investment usage. Normal transfers are free and WiseBaynan earns it money off additionally services that customers decided to use.)

 

Regarding my Acorns account, I invest about 10-20 dollars per month. What is Acorns? (I'm actually really excited to talk about this one). Acorns is an investment account that I can put money and it will automatically invest that money into various market indexes (Some stocks, some government bonds, some company bonds). Because the money is sufficiently diversified, it is extremely safe from a market crash. Additionally, if I need to have access to that money quickly, I can withdraw it and have it within my bank account within seven days. What is equally exciting about Acorns is how their fees are set up. For people under 24, Acorns is free to use. (Note: after age 24, Acorns costs one dollar per month for accounts under 5,000. For accounts over 5,000, there is a .25 percent management fee, which is fairly low.)

 

Regarding the 401(k) that I will set up once I qualify, I will attempt to maximize my allowed contribution every year because many employers will match that contribution dollar for dollar! When is the last time someone told you that they would give you thousands of dollars if you saved the same amount for later? It is a fantastic program. Now, 401(k)s can be fairly personalized (to my knowledge), but once I can get one, I will invest in market indexes and fairly aggressive to maximize return.

 

What should the main takeaway from this short novel of a post be? Never use credit cards, save 3-6 months worth of income in a savings account for emergencies, and to start saving for retirement immediately. Remember, every dollar that I save right now will be worth 32 dollars once I'm seventy. Instead of a candy bar, I can afford an entire lunch for me and my future wife; instead of a Macbook, I could afford a new car.

 

If you want to read more about investing, I would recommend The Elements of Investing by Burton Malkiel and Charles Ellis. In this book, Malkiel and Ellis attempt to break down investing down into one single simple book so that ordinary people can read with ease. It is short, sweet, and cheap, 24 dollars on Amazon.

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