The Miracle of Compound Returns

The Miracle of Compound Returns


♪ [music] ♪ – [Narrator] Previously,
we learned about opportunity cost. But how can this concept
help us save smartly? We’ll dive into an example illustrating the miracle
of compounding, and use opportunity cost
to understand the importance of saving and investing
early and often. Let’s take these two
investment scenarios. In the first scenario,
meet Myopic Mary. She starts saving in her 30s, and by age 45 has $20,000. She then invests this money
in a retirement fund that earns a 7%
annual rate of return and doesn’t touch her investment
until retirement. How large will Myopic Mary’s
$20,000 grow to be if it’s growing at 7% for 20 years,
until she turns 65? For simplicity,
we’ll use the Rule of 70, which allows you
to quickly approximate how long it will take
for an investment to double in value given a specified rate of return. To see how many times
Myopic Mary’s $20,000 will double, simply divide 70
by the rate of return or growth. So 70 divided by a rate of return
of 7 equals 10, which means her money doubles
approximately once every 10 years. Since she’s investing for 20 years,
her money doubles twice. Myopic Mary’s $20,000 doubles
to roughly $40,000 by the time she’s 55, and doubles yet again to $80,000
by the time she’s 65 and ready to retire. So she started with $20,000,
did not save a single cent more, reinvested her returns, and, after 20 years,
ended up with about $80,000. Not too bad! Now, onward to scenario two. Imagine Myopic Mary
goes back in time 10 years, and becomes Meticulous Mary. Meticulous Mary
starts saving in her 20s so that by age 35 she has $20,000. At this point, she invests
her money in a retirement fund that earns a 7%
annual rate of return and doesn’t touch her investment
until retirement. Our Rule of 70 calculations
are exactly the same as scenario one. Given a 7% annual rate of return, Meticulous Mary’s money
will double every 10 years. The only difference
from scenario one is that Meticulous Mary’s money
will double three times instead of two times. She now has 30 years
until retirement, instead of 20. Meticulous Mary’s $20,000
will double to $40,000 by the time she’s 45, will double again to $80,000
by the time she’s 55, and will double yet again,
to $160,000, by the time she’s 65. So, let’s recap. Both Marys, Meticulous and Myopic, invested the exact
same amount, $20,000, at the exact same
rate of return, 7%. The only difference between
these two scenarios is time. Meticulous Mary started investing
just 10 years earlier, and that led
to $80,000 more dollars. How can that be? It’s the miracle of compounding! Meticulous Mary started saving earlier, and that means that
when her investment reached $80,000, she had one more 10-year period, one more doubling period
still to go. And it’s that last doubling
that is the biggest doubling. When people start to save,
it often seems slow and pointless, because things
don’t change all that much. The rate of absolute change
gets faster and faster. This is what people mean
by exponential growth. And keep in mind, Meticulous Mary
stopped saving at 35. Imagine if she had continued
contributing to her retirement fund until she retired. That would be an extra 30 years
of additional savings, and additional compound returns. Now let’s think about this through the lens
of opportunity costs. Every dollar Meticulous Mary had
and invested at 35 turned into $8
by the time she was 65. Contrast this
with poor Myopic Mary. Every dollar she had
and invested at 45 only turned into $4 at 65. Quite the difference! But the real takeaway
from these two scenarios is not about Meticulous
or Myopic Mary. The real takeaway is that
you should be saving and investing early and often. And yes, I understand —
saving is hard to do. And where should you even
save and invest? Fear not. We’ll cover some helpful saving tips and details
about common retirement plans in future videos. – [Narrator 2] Check out
our practice questions to test your money skills. Next up, we’ll cover
some specific saving tips so you can invest early and often. ♪ [music] ♪

15 Comments

  • Ronald Rebolledo

    September 20, 2016

    where the hell do you get a 7% return?

    Reply
  • thrillscience

    September 20, 2016

    Except you can't get 7% these days because of the War on Savers. Interest rates need to be held at zero to keep house prices propped up.

    Reply
  • Analytically Sound

    September 20, 2016

    Your video quality has shot up exponentially, nice job.

    Reply
  • Walter Conner

    September 21, 2016

    Question what is a dollar? What will the purchasing power of that currency vs original purchasing power of those said dollars?

    Reply
  • Walter Conner

    September 21, 2016

    For those who question where to get yield REITS, MLPs, and perfered shares, oil shares, IEP has a decent yield. Their isn't a thing known as safety only a dangerous world that you can mitigate risk and diversify assets. I like gold the most but it doesn't produce income though but it can't default or go bankrupt either.

    Reply
  • Vicko Seno Saden

    September 23, 2016

    how about marketing topic?

    Reply
  • Al mesiah Troops

    July 30, 2017

    Work hard at young age and millionaire at dying moment. Reality

    Reply
  • Gogoleate este

    February 19, 2018

    When meticulous Mary was 20 she had the W presidency for 8 years and her investments didn't compound shit until she was 30, now she shares her destiny with myopic Mary that started at 30….

    Reply
  • Tech Stuff

    April 22, 2018

    myopic Mary had more fun spending her money when she was young –

    Reply
  • Pray To The Only God

    May 22, 2018

    4 sins are the source of humanity major trajedies, and mindlessness, for these 4 sins, God promised eternal hellfire for doers in the day of judgement:

    1- Praying to another deity with God.
    2- Murder
    3- Fornication/Adultery
    4- Persistence in eating usuary

    Reply
  • M

    June 13, 2018

    I'm 23 with about $20,000 to invest, just opened a mutual funds account today. Eventually will open a direct investing account so I can buy ETFs, just wanted to learn the basics first. I'm excited about this!

    Reply
  • chelsey hough

    July 16, 2018

    Not true you can get around 8% net return on commercial property investment alone i.e student property in the UK. You just have to Google and there is always options ok granted itay be for a fixed period however just reinvestment after that period

    Reply
  • Cornell Benefield

    August 3, 2018

    inflation will ruin the dream of compounding interest.

    Reply
  • QueenOfAll_ Lady Rose

    April 18, 2019

    The number is 72 NOT 70!

    Reply
  • Ray Cervantes

    May 15, 2019

    where the F is she getting an annual rate of 7%

    Reply

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