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Retirement Planning made easy: How does compound interest effect your retirement goals?

Updated on February 15, 2012

Retirement planning made easy

Question: How do you make retirement planning easy?

Answer: Start while you are still young.

Easier said than done, right? Well, the beautiful thing about starting to save for retirement while you are still young is that you have longer for those investments to grow.

The truth is that the earlier you start the less you have to save. If you were to start while you are still in your teens or twenties there is a very good chance that you could stop saving altogether in you thirties and never have to worry about it again. Wouldn't that be nice. Savve for 10-15 years, never save again, and still have the ability to retire comfortably when you are in your 60's.

I provided some basic examples below to show you all the power of compound interest.

Compound interest

Compound Interest Formula

P = principal amount (the initial amount you borrow or deposit)

r = annual rate of interest (as a decimal)

t = number of years the amount is deposited or borrowed for.

A = amount of money accumulated after n years, including interest.

n = number of times the interest is compounded per year

How exactly does compound interest work?

Some quick examples of compound interest...

Example A: Let's say you have $10,000 in the bank and you are looking to invest and happen to find a safe mutual fund that pays out an average interest rate of 12% and you decide that you are going to store it for 20 years before you are going to withdraw your funds.

Principle (P) = $10,000

Interest Rate (R) = 12%

Time (T) = 20

At the end of the 20 years you would have $96,462.93 (check it for yourself with this free online calculator)

Now let's see how extending the time frame can affect your earnings. We will keep the initial principle and interest rate the same and only change TIme (T) value to 40 years. The time value is now twice as long, so it is logical to assume that at least double the amount made in 20 years...

Example B:

Principle (P) = $10,000

Interest Rate (R) = 12%

Time (T) = 40

At the end of the 40 years you would have a total of $930,509.70... almost 10 times more than you would have made after 20 years! That is enough to retire off of for more people, and the beautiful thing is that if a 20 year old were disciplined enough to set aside $10,000 and let it sit for 40 years, he would have that option to retire at 60 years old. This example is assuming that the 20 year old never puts another dime towards retirement again.... What would happen if you considered adding additional principle to your retirement planning?

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Some of my other writings:

Adding additional principle to your retirement savings

Adding additional principle to compound your compounding interest

For those of you who were still not impressed with the compound interest you saw in Example B (where an initial investment of $10,000 grew to almost a million dollars over the course of 40 years), I think we will have to take it one step further by showing how depositing additional principle in your retirement funds can affect your money years on down the road. In order to keep everything consistent, what do you think would happen if you after the intial principle amount of $10000, you were able to continue adding $1000 per year...

Example C:

Principle (P) = $10000

Interest Rate (R) = 12%

Time (T) = 40

Annual Addition (A) = $1000

At the end of the 40 years (age 60 if you had deposited the initial $10,000 at 20 years old), you would have $1,789,652.10... This would be a very comfortable retirement!


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