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Compounding Returns Are Worth Millions

I gotta give my mom credit, she tried to get me to set some money aside starting at age 18. She opened a mutual fund savings account for me and contributed $50 every month to it. Some time towards the end of college I raided the account, never realizing what I did to the potential compounding effects of that money.

In this short post I want to revisit the power of compounding once again. For those of you who have offspring, you can set aside a lot less money than you think and watch it grow to impressive sums.

For the rest of us – the greedy ones who don’t want kids – the compounding effects of our savings and investments can make us richer by millions of dollars. After all, it’s not just that you’re contributing a set amount month-after-month; the money also has an additive effect, growing not linearly but curving upward faster and faster depending on the compounding interest returns.

Bankrate has a good Compound Interest Calculator you can play with.


$50/month Since Age 18

If I hadn’t touched the money in my Putnam Mutual Fund account from age 18 until now, age 41, I would have had 23 years of compounding interest rates for $50/month.

The historical returns for that money would have been 9%, looking back. I would have had $47,000 sitting there with nothing more than a $50/month contribution. It’s not that $50k is a lot of money. Rather, $50/month is nothing, it’s a dinner out, a weekend of playing arcades, or a tennis lesson.

Teaching the Habit

My mom always had a business-savvy mind but because she was also working and running the household with very little support from pops she ended up getting stretched too thin. Finally, you can try to do the right thing for your kids but if they decide to wreck it, not much else you can do.

As kids we learn from the actions of our parents and not what they say or teach. My parents weren’t frugal with their money. They assumed there is always more money to be had. Yet my mom completely burnt out from her Daycare Business. Even though it was very lucrative she couldn’t do another day of it.

Relying on the Future

Once that happened, my sister had a kid and my mom needed to help out. Then the economy tanked. Opportunities disappeared. My parents fell behind on the mortgage of the house and they eventually lost it to the bank.

You just can’t rely on the future. You can’t assume that there is more money to be made around the corner. Maybe you’ll fall ill, maybe other responsibilities will distract you. You might lose your medical license. Burning out from medicine is a real possibility. You might get addicted to gambling, porn, drugs, or social media.

$50/month for 50 years

Even if you’re broke as a joke, $50/month is something you can always manage. If I were to continue that $50/month for 50 years, from age 18 until age 68, I would have had $500,000 in investment savings.

What blows my mind is that you never saved up $500k, you only dished out $50/month for 50 years which comes out to $30,000. That’s it. $30k got turned into $500k. It’s not magic, it’s math. I didn’t appreciate this before, but my mom somehow did. Now I get it.


$500 per month

For the residents who are about to be attendings, it’s not too late to start saving. The key is to not interrupt the compounding effects of your investment. Raiding your retirement accounts or cashing out index funds too early kills your returns.

Starting at age 30 if I set aside only $500/month – 2.5 hours of work per month doing telemedicine – I would have nearly $1,000,000 40 years later. That’s at a very conservative 6% annual compounding rate.

Learning the habit is critical. It’s just hard imagining that $500/month is one day going to turn into $1M. Much like going to the gym, it’s the habit of doing something regularly. Sometimes it’s easy and other times it’s a pain in the ass.


Roth IRA Contributions Kids

Any parent can “hire” their child and max out that child’s Roth IRA account. It’s been $5,500/year up until recently and the limit has increased to $6,000 as of 2019. That’s $500/month which, as we saw, can grow to impressive dollar amounts in the future.

If you don’t teach your kids basic finances then they will likely do what I did, raid the account as soon as the need arises. Alternatively, you could set the money aside yourself under their name and gift the money to them at a later date.


Interest Rates

Interest rates matter a lot. A mutual fund, such as a passive index fund, growing at 5% a year is very different from a similar index fund which grows at 8% a year.

A 30-year investment of $500/month at 5% annual rate of return will grow to $400,000. At 8% it would be worth nearly double that, $710,000.

Far more important than the interest rate is the investment time horizon. 30 years of compounding or a high monthly investment amount can overpower the interest rate. Aim for consistency and increase that dollar amount whenever feasible.

Years to Maturity

You don’t have to stop saving when you retire. Maybe your parents started a mutual fund savings for you at age 18. They contributed to it until you turned 30. You then continue to contribute to it until age 65.

If you’re still earning money at age 65 then you can let the money grow. And you can still contribute to it. Even if you stop contributing to it the money will grow because the investment is still compounding at a specific rate of return.

A $500,000 investment will grow to $2.1 million if it remains untouched. The money will continue to compound at around 6% per year for another 25 years. Few retirees take this into account. They assume that once they retire they will be raiding their savings.

Increasing Your Annual Contributions

The final scenario I’ll present is how your contributions might increase as your financial situation improves. At first you might only be contributing $500/month over the same 30 year time horizon.

But eventually your student loan debt disappears. Your children move out. The mortgage gets paid off. Your income, too, will increase year after year.

Assuming that you increase your contributions by 10% every year with that initial $500/month, you will end up an investment balance of $1.9 million. I suspect that many of us can blow this 10% up. By the time we approach the later years of our career we can contribute quite a bit to our investments.


Persistence Pays Off

I have about $600k invested in the securities market; mostly index funds. Even if I were to never contribute a penny to these accounts it will likely grow to $2.5 million 25 years from now. For this I have assumed an annual rate of return of 6%.

Because I’m not inherently frugal, because I love spending money, I have decided to set aside around $500/week of my money for as long as I can. Assuming that I can continue doing this for the next 25 years, my investments will grow to nearly $4 million.

Even if I only contributed only $500/month the money would grow to $3M instead of $2.5M – still an impressive amount.

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