Remember that scene in Wayne’s World—the one where Wayne says, “He tells two friends, and they tell two friends, and so on, and so on … ” and the screen keeps splitting into more and more Waynes?
That’s basically how compound interest works, except instead of accumulating Waynes, it’s your money that multiplies.
“Because young people have many years of earning power, understanding compound interest early is important,” explains Ash Exantus, a.k.a., “Ash Cash,” a personal finance expert and financial empowerment coach at BankMobile.
Here’s what he means: For every year your money is stashed away in some kind of savings account or investment vehicle, it earns interest. And every year you leave that money alone, you continue to earn interest both on the original amount you put away and also on the interest you’ve earned in the past, Exantus says.
That may not sound like a big deal. But this example will put compound interest in perspective: If you set aside $1,000 at age 25 and it earns 10 percent each year until you retire at age 65, your thousand bucks would balloon to nearly $54,000. Put away that same $1,000 at age 35? You’d end up with under $20,000.
“Big difference!” Exantus says.
Like a jumbo jet that takes time to lift off from the runway, your savings don’t really start to accumulate until years and years on. But once that accumulation takes off, it soars.
So while 40- and 50-year-olds who never saved have to invest in risky stocks or real estate deals to try to accumulate retirement funds in a hurry, you only need to kick aside a small amount of cash for your golden years if you start saving early, Exantus says.
He recommends putting your money in a traditional 401k or IRA savings account. Because money you put in these accounts can earn interest tax free, they’re “like compound interest on steroids,” he says.
More good savings advice: Keep all your savings in one place—like that 401k Exantus mentioned. Knowing you have a big pot of cash in the bank will inspire you to save more than if you had the same amount spread among a bunch of different investment accounts, shows research from the University of Toronto.
It also helps to visualize a specific savings goal, like the ability to travel the world when you retire—or to buy a vacation home on your favorite beach. Whether you’re saving money for retirement or stashing cash for a new car, keeping a target purchase in mind helps motivate you to stick with your savings, finds a study in the Journal of Marketing Research.