The Power Of Starting Early

by: Stock Market Sherpa

Summary

The compounding effect of investment returns means that investing over a long period of time can generate significant returns.

Therefore, beginning to invest while young is essential to building wealth.

This article demonstrates just how powerful this concept can be in practice.

On this investing website and many others, we tend to focus a lot on returns. We try to make decisions to maximize return or minimize risk or achieve a reasonable combination of both. However, we don't often discuss the time frame over which our returns occur. Investment returns become most powerful when they compound over long periods of time. Therefore, giving your investment portfolio the longest possible time to compound can make a significant difference to its overall performance.

This article will only apply directly to a minority of readers, because it demonstrates the immense power of beginning to invest at a young age. However, the rest of you likely have children or grandchildren or nieces or nephews or friends who may benefit greatly from taking some of this advice to heart (and I urge you to share it with them).

Below, I have created a simple graph which outlines four portfolios. In each case, $5,000 per year is invested up to age 65 and the annual return is 6%. The only difference is the age at which these portfolios were created:

  1. Orange Line - Age 25
  2. Green Line - Age 30
  3. Blue Line - Age 35
  4. Red Line - Age 40

This table outlines the final value of the portfolios at age 65 and the investment gains realized over the entire time period:

Starting Age

Amount Invested

Ending Value

Investment Gain

25

$200,000

$820,238

$620,238

30

$175,000

$590,604

$415,604

35

$150,000

$419,008

$269,008

40

$125,000

$290,782

$165,782

Not only does the portfolio that was started at 25 grow to be nearly double the value of the portfolio started 10 years later, the investment gain achieved is more than 130% higher! Even if one is only able to start investing at age 35, he or her ending result is an additional $100,000 of investment gains compared to someone who begun at age 40.

It is shocking just how impactful this compounding effect of wealth can be. However, since this type of financial math is not often taught in school, by the time most men and women learn about it (if they learn about it at all), they have already missed out on much of its potential benefit.

Going back to the above example - the portfolio that starts at age 25 reaches a value of approximately $820,000 by age 65 with annual deposits of $5,000. To reach that same final value, how much higher must the annual deposits be in each of the other three portfolios?

If one starts investing at age 30, annual deposits of $8,420 are required to reach that $820,000 ending value. Wait until age 35 to begin building this portfolio and the necessary annual deposit jumps to $11,580. And if one only begins investing at age 40, it will take annual deposits of $16,250 (more than 3 times the original $5,000 amount) to reach $820,000 by age 65.

Beginning to invest at age 25 might not be realistic for everyone. The job market is not easy for young men and women. Many individuals of this age may well have student debt to repay and or be looking to start a family. However, it is difficult to argue with the striking figures outlined in this article. Even 5 years can make a world of difference - the earlier that one gets the power of compounding investment returns on their side, the brighter their financial future.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.