#NRSW18: Are You Benefiting From This "Magic" Money-Growth Strategy?

October 23, 2018

Today’s millennials number 83.2 million and—<humblebrag>—are the largest, best educated, and most diverse generation in U.S. history While at one time these young adults might have been regarded as less financially savvy than previous generations when it comes to saving for retirement, budgeting, and establishing and maintaining a financial plan, it would seem that view is becoming outdated.

According to Bank of America’s 2018 Better Money Habits Millennial Report, millennials are saving at the same rate as Gen X (but feel more financially secure than Xers), and are more likely to have a specific savings goal than both Xers and Baby Boomers. But that doesn’t mean that they’re unconcerned about the future. According to a report released earlier this year by the National Institute on Retirement Security (NIRS), nearly half of millennials are worried that they won’t be able to retire when they want to, while two-thirds are concerned about outliving their retirement savings.

It’s no wonder they’re worried. That same report from NIRS indicates that half of millennials are expected to live to at least 89, and with their increased life expectancy, lower income replacement from Social Security, and lower likelihood of having a traditional defined benefit plan—unless they’re a PERA member, of course—they will need to save significantly more than previous generations to maintain their current lifestyle during retirement. In fact, some experts estimate that this age group should start saving 15-22% of their salary as soon as possible in order to meet the $1.5-2 million target they’re projected to need at retirement. Yes, you read that right; if you’re part of the millennial generation, you should set your sights on becoming a millionaire if you wish to enjoy a secure retirement.

OK, so you might be thinking to yourself at this point, Oof, that is a very intimidating goal. But at least being good savers is a step in the right direction. Well, yes and no. It’s very good that millennials are accustomed to and more importantly, want to save. The thing is, though, there’s a good chance they could still fall behind on their retirement savings goals because they’re not saving in the smartest way. In other words, they’re not taking advantage of the magic of compound interest.

Let’s explain:

According to a national survey cited in this article, millennials are more inclined to open savings accounts than to invest in employer retirement plans or tax advantaged plans. This means that they’re effectively leaving money on the table by not taking advantage of accounts that allow them to reap the benefits of compound interest.

What is compound interest, you ask? In a nutshell, compound interest is the term for when the interest on your savings earns interest. It means that the money you’ve made is, in effect, itself making money. More to the point, it means that if you need, say, $1.5 million to retire, you don’t actually have to save (or earn) that amount in your lifetime. Instead, you can put away a little bit at a time, allow the winning combination of time and interest to work their magic, and come out on the other side with a bunch more money than you put in.

Here’s an example (courtesy of The Practical Penny):

Let’s say that you invest $10 at 10% interest today. In one year’s time, your investment will have earned $1, giving you a total of $11.

Leave that money alone for another year, and you’ll have $12.10. The $1 you earned the first year (that you didn’t have to do any work for, by the way) has now earned you $0.10.

At the end of 10 years, that $1 that you earned in the first year will have earned you another $1.36. Even better, the $10 you originally invested continued to produce $1 each year, and those additional dollars helped you earn even more each year. In total, the initial $10 investment will be worth $25.94 at the end of 10 years. That means you get almost $16 with no work on your part.

What about that same $10 after 50 years? It will be worth $1,174. We told you it was magic.

Now, let’s say that instead of investing $10, you invested $10,000 at 10% this year. In 50 years, you’d have $1,173,909. Yes, compound interest allowed you to become a millionaire with a simple $10,000 investment.

That millennials tend to prefer savings accounts to employer retirement plans or tax advantaged plans is alarming because the average savings account at a major bank has a paltry 0.01% interest rate. The S&P 500, meanwhile, has over the course of time been pretty consistently at a 7% rate of return, adjusted for inflation. It seems like a no-brainer, right?

So this National Retirement Security Week, we implore you to rethink your retirement savings strategy. Take advantage of your employer’s retirement plan if you have one. If you don’t, open an IRA or other individual retirement plan. Start contributing as early as you can to allow the winning combination of time and compound interest to work their true magic. Whatever you do, step away from the bank savings account as soon as possible. Your future depends on it.

For further proof of just how powerful compound interest can be, take a look at this video from our friends at the National Association of Government Defined Contribution Administrators: