Many people have heard of the power of compounding. But it’s another thing to take a fresh look at the actual numbers. Consider how money can accumulate in an IRA for someone who starts young and leaves the money untapped until retirement.
Right now, the maximum contribution to an IRA is $5,000 a year for someone under age 50 (your income must be at least that high; the source of funds can’t be a gift). Let’s look at what would happen if by the time someone turned 20, they had saved and earned enough to put $5,000 in an IRA as a one time only contribution. Now let’s invest that money in a broad stock market index and earn the average return of stocks over the last century, ten percent. After 50 years, the account would be worth $587,000 (remember this doesn’t factor in inflation).
Now if that same person waits ten years, until he’s 30, to invest, the total at retirement would be less than half, $226,000. At 40, it would be cut to $87,000. At 50, it would be $34,000 and waiting till 60, the total would be only $13,000.
These are, of course, average figures and the results generally would differ significantly from this illustration. But this does make a number of important points. First, the length of time you invest – whether it’s for yourself, your children or your grandchildren – is critical. The benefits of tax deferral make a huge difference. And achieving the returns of the broad stock market has been a great goal.