From Business Insider:
One way to set up this problem BEFORE showing the chart is to ask your students the following:
I will profile three people who made different decisions about saving for retirement. Tell me who had the largest “nest egg” when they were 65:
- Susan remembered the mantra “Save for retirement when you are young” and developed that habit. From the ages of 25-35, she invested $5,000 per year and then watched her investments grow. So, over the ten years she invested $50,000.
- Bill was a steady saver, however, he didn’t get started until he was 35. For 30 years, he invested $5,000 per year for a total investment of $150,000.
- Chris was a steady saver too, but started investing when he was young too. He invested $5,000 per year between the ages of 25 and 65. His total investment was $200,000.
Assuming each of them averaged a 7% annual return, who had the largest “nest egg” when she/he was 65 years old?
Answer: Chris (the blue line)
Then show the students the chart and ask them what surprises them.
- Susan invested 1/3 the amount of Bill ($50,000 vs. $150,000) and still had a larger account at age 65 ($602K vs. $541K). This demonstrates the power of compound interest and the longer the time horizon the more of an impact it can have.
- Again, showing the power of compound interest, each of the investors earned a multiple of their original investment (for example, Susan’s balance at 65 is more than 12X her original investment of $50,000)
- Savings account as a label on the graph is deceiving. History suggests that an investor would have to favor investing in equities (stocks) in order to achieve a 7% annual return.
- Inflation will erode the value of their “nest eggs” at 65, so $1.1 million in 40 years is worth a lot less than it is today.
A final question for students: how will you use this knowledge you have about compound interest?