Chart of the Week: Why You Should Invest When You Are Young?

From Business Insider:

CompoundInterest

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?

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Answer:  Chris (the blue line)

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Then show the students the chart and ask them what surprises them.

Key takeaways

  • 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?