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The Importance of Saving
By Myles Johnstone
How can ordinary, even low-income, if not poor, Americans become rich? The answer to that question is as simple as it is mandatory: Start by saving and investing something regularly, even if it is a modest amount, in anticipation of big returns in the future.
Your persistent savings will add up with time. One hundred dollars saved each year will cause your total savings to rise from $100 to $1,000 in ten years. However, your net worth (or financial wealth) should grow, over time, by much more than the sum of your savings. This is because of the power of compound interest. This means that you should expect to receive on your savings some rate of interest (or return or appreciation) each year. If you leave the interest in your account, your interest will "compound" because you will then receive in subsequent years interest on your savings, plus interest on the interest that you received in previous years.
Again, if you save $100 for ten years and receive an interest rate of 10 percent, your total savings with interest will grow from $100 the beginning of the first year to $210 the second year ($100 of savings the first year plus $10 of interest on the first year's savings plus $100 of new savings), to $331 the beginning of the third year, on to $1,594 the beginning of the tenth year. In short, with compound interest you will have close to 60 percent more in net worth at the beginning of the tenth year than you would have had from the savings alone.
You can imagine with "interest on interest"—or compounded interest—your net worth will build progressively more rapidly with each passing year. With sufficient savings, enough patience, and a reasonable rate of interest on your savings (or return on your investments), you can imagine that your net worth (and resulting income level) in the future will be the envy of those who have chosen to spend all their income year after year on many things they could do without, or do with less of.
To dramatically illustrate just how powerful compound interest can be in building wealth, suppose that you are a newly minted twenty-two-year- old college graduate, with a starting salary of, say, $30,000 a year, and you salt away a mere $2,000 the first year, and only the first year, on your job (which means that you will then save only 6.6 percent of your annual pre- tax income that one year).
Assume that you are able to secure an annual rate of return on the investment (above the inflation rate) of 15 percent until retirement. Amazingly, your onetime investment will be worth, in the purchasing power of today's dollars, $814,774 at age sixty-five and over $1.64 million at age seventy.
Author Details:
Myles Johnstone writes exclusively for finance related sites such as Refinancing Finance Info.com, Vehicle Finance Info.com and finance Solutions info.com
Source: Financial Articles
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