BB&T Scott & Stringfellow Logo

The Power of Compounding

The sooner you start an investment program, the more likely you will achieve your financial goals. The reason is simple: the sooner you invest, the longer your money has time to compound. Compounding is the money you earn on principal, plus the money that was earned earlier.

Just look at how compounding works with relatively small amounts of money. If you invest $100 monthly in a security that earns 8% annually, you’d have $18,295 in 10 years and $149,035 in 30 years. The more you invest, the greater the potential. For example, if you just add another $100 each month to the same investment, you’d have $36,589 in 10 years and $298,071 in 30 years.

The power of investing early takes on even greater significance when you invest in retirement plans, such as IRAs and Keoghs. That’s because all earnings in these accounts grow tax-deferred for as long as they remain in the plan. You pay taxes on earnings only when you withdraw them, usually at retirement when you will presumably be in a lower tax bracket.

What does it mean to have your money grow tax-deferred over time? The answer is plenty. In the example above, you saw how a $200 monthly investment over 30 years earning 8% grew to $298,071. But if you made this investment in a fully taxable account and were in the 28% federal income tax bracket, you would accumulate only $193,502 after tax payments - nearly $90,000 less! The higher your tax bracket, the more you would have to give Uncle Sam. Add state and local taxes and you’d earn even less.

How do you develop the discipline to invest regularly, particularly if you have had problems putting money away in the past? Easy. Develop a habit of setting money aside for investing before you pay your monthly bills.  Think of it as paying yourself before you pay anyone else. Once you get into this routine, you’ll see how quickly you can accumulate wealth.