Amanda and Fabian were best friends growing up. They lived in the same neighborhood, went to the same school, played the same sports, and were interested in the same things.
In high school, they both enjoyed education and went to the same university to become teachers. During school, they both worked on campus and earned enough to pay their room and board with a little left over every month. With a stroke of good luck right out of college, they even got the same teaching gigs in the same school district, receiving the same sufficient—but certainly not extraordinary—salary.
Amanda and Fabian were similar in nearly every way. But there was one particular way Amanda and Fabian differed quite a lot.
Starting at age 19, Amanda opened a retirement account and made it a point to sock away a bit of money every month. On average, she saved $2,000/year and had a simple strategy of investing in a few diverse index funds of companies that paid dividends. Fabian decided that, since he was young, he had plenty of time to get started with his retirement savings.
Amanda kept up her investing habit until she was 27-years-old. That’s the year she decided teaching was no longer for her. She quit her job and, without any income, stopped saving for retirement also. When she found her true calling as a surf instructor, she moved to an island in the South Pacific, earning even less than before, and never got around to saving for retirement again.
In total, Amanda put $16,000 of her hard-earned dollars into her retirement account.
Fabian got a later start than Amanda, but finally got around to saving at 27—just when Amanda stopped. He automated his savings so that it was easy and put away $2,000/year just like Amanda. Only Fabian did it every year for 39 years until retiring at 65. He invested a whopping $78,000 over the years.
But this isn’t the end of the story.
When Amanda returned to her hometown years later and reconnected with Fabian, they got to talking about retirement. Fabian was living a modest life from his years of saving, but he felt bad even mentioning it to Amanda knowing she’d quit saving almost 40 years ago. She must be living in poverty, right?
Wrong! Fabian was shocked to hear that Amanda was living the same lifestyle he was. But how is that possible? Fabian saved for years and years. Amanda saved for just a few and then gave up.
How did they both end up at 65 with the same amount of money? How’s that fair? How’s that even possible?
It may not be fair, but it’s certainly possible. Here’s how.
Compounding Interest: How Amanda Retired On $16,000
It doesn’t seem fair—or even possible—that someone could save for just a few years and still out earn someone who saved almost their entire adult life.
But it is possible, and it’s all thanks to a mathmagical™ formula called compounding interest.
Thanks to their smart investing choices, Amanda and Fabian both benefited from an average 9% annual return (6% market return + 3% dividends that were reinvested).
Compounding interest works by adding just a bit of money to your investment in the early days (when Amanda was 19), but then—over time—interest builds up not just on the money you invest, but the interest from years past as well. Interest builds on earlier interest that builds on even earlier interest, and on and on.
secret well-documented effect of compounding interest is that the longer you allow it to build, the greater its force becomes.
That’s how Amanda was able to grow her retirement savings to nearly $700,000 (an annual retirement income of $28,000) by investing only $16,000. She started 8 years earlier than Fabian. Here’s exactly how their money grew over the years:
In the beginning, Amanda’s interest amounted to very little. But by the time she was 65 and needed the money, the interest had compounded for years, skyrocketing her balance. Even though Fabian tried to catch up by investing for most of his adult life, he still didn’t beat Amanda, who gave up a full 39 years before him.
So what does this mean for you?
How To Put Compounding Interest To Work For You
The #1 lesson to learn from Amanda’s story is that fortune smiles on those who take action. From an early age, she saw that investing in the future was important, and it paid off even though she abandoned the plan after only 8 years. She wasn’t deterred by the fact that she was young and not making a lot of money.
But what if you’re not 19 and you don’t have much money to invest? If you’ve invested since you were young, you might feel pretty good right now. But if you haven’t, you might feel a little deflated—like anything you do now is too little, too late.
As a Smart Riskologist, you know leading a successful life means working to make progress, not comparing yourself to others or trying to outdo anyone. You know that, even if you have limited resources, you can find a way to improve your life. And you know the best time to start something important is now, even if you wish you’d started earlier.
So take Amanda’s lesson as one of encouragement. Think of it as motivation—”Look what I can do if I start now and don’t wait.”
And then set aside a day to open your retirement account and get started. Amanda is proof that a little can go a very long way.
Yours in compounding,
P.S. I use an excellent service called Betterment to quickly and easily manage my retirement and several other investment accounts. If you sign up using this link, you’ll receive $25 and I’ll receive $10.