Can the power of compound interest help savvy Millennials grow a million dollar portfolio?
If you tell the average twenty-two year old Millennial that the best time to start saving for retirement is yesterday, they may throw you an incredulous glance. “Are you kidding?” they may say, “I’m not due to retire for another forty years!”
Millennials, usually defined as those born between 1980 and the early 2000s, may go on to argue that they’re busy starting a family or paying down student loans and they simply don’t have the money to worry about retirement.
However, according to Financial Advisor, T. Gregory Naples, starting your retirement plan early and taking advantage of compound interest may be the single easiest way to retire with a potentially impressive nest egg.
Naples, who runs The Naples Wealth Management Group in Hudson, Ohio with his son Christopher, often tries to catch the attention of the children and grandchildren of his clients by pitching them a series of quick scenarios.
One such scenario is the simple math of compound interest. Say 22-year-old Bob makes $60,000 a year and retires at 65. He contributes 10% of his pre-tax salary into his 401(k) retirement account while his employer chips in 2%. Assuming he consistently makes that 12% monthly contribution of $600 at a reasonable 5% rate of return, he could end up with $1,057,000 at retirement.
Sally, however, contributes $1,000 a month at the same rate of return, but she doesn’t start until age 45. By the age of 65 she will have $448,000 in her retirement account—roughly 43% of what Bob has saved. Witness the power of compound interest at work.
While many investors go in search of the magic triple-digit stock gain, Naples says young investors shouldn’t overlook the power of consistent contributions that take advantage of compound interest—even if the contributions begin very small.
A frequent complaint that Naples hears from Millennials is that they simply don’t have the excess cash to invest. Using the example of Bob and Sally, he fights this misconception as well.
Say Bob complains that he can only afford to put away 4% a month due to his student loan and tight budget. Assuming the same rate of return over 43 years and a 2% employer match, he will have $528,000 at retirement—still 8.4% more than Sally even though his monthly contribution was 40% less than hers and overall he contributed $103,000 compared to her $240,000.
While that may not be enough for Bob to retire on, a recent study by the US Government Accountability Office showed that 29% of Americans over 55 have no retirement savings whatsoever1. So even small contributions can make a big difference to your overall retirement savings.
Naples uses examples such as these to catch Millennials’ attention. Once they’re convinced, he starts them out in managed mutual funds until they reach $50,000. After that, he often switches them to more transparent and lower-cost stock and bond funds managed by institutional money managers.
But first and foremost, Naples tells them to use the tax-free environment of the 401(k) to put compound interest to work for them. “I tell them it’s the most important investment they’ll make for their retirement. It’s literally like watching grass grow.”