The Wondrous And Fantastic Power Of Compound Growth

(And Why It Doesn’t Pay to Wait)

It’s so easy to assume that saving, investing, and even considering a retirement is something to do later. Unfortunately, well…no. We don’t need board room salaries or country club memberships to consider a retirement. But we do need an ally. And who can we put on our side of the ring? Compound growth.

Today we delve into the concerning data behind millennial retirement planning, some misconceptions on what retirement should be, and the shocking power of compound growth and how it can, quite possibly, save us from ourselves.

Back in late 2019, we took a deep dive on the cost of not considering retirement at an early age: Retirement? Don’t Worry, I’ll Be Fine!

We shouldn’t be surprised by human kind’s tendency to disproportionally value now (the tangible) over later (the seemingly intangible). Right? When we were hunched over, clubbing bison, and sewing loin cloths we didn’t need to dictate much critical brain power to anything other than that damn wriggling bison and the finicky loin cloth.

Well, the world has changed faster than our brains can keep up. Modern man still has a tendency to overvalue now, even if to our detriment. And nowhere is that more apparent than with money.

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If you want to know how long you need to work, simply calculate your savings rate:

Shockingly, more than 50% of workers age 50 and above are being pushed out of long-held jobs.

Retirement Doesn’t Just Happen

Retirement is not something just happens when you get to age 65. Your boss doesn’t walk up, pat you on the small of your back like a burping baby, throw some confetti, pop a shrill-but-well-intentioned chirp out of a party horn, and wish you off into the sunset. Unfortunately not. He or she reluctantly waits until you are disgruntled, cynical, overpaid, and twenty years behind on the latest technology before huddling you into a conference room with an HR representative, a security guard, and your severance papers.

Shockingly, more than 50% of workers age 50 and above are being pushed out of long-held jobs.

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You Can’t Get Strong by Saturday

As climbers we (hopefully) now know that we can’t build finger strength by Saturday if we start on Wednesday. So why do we spend so little attention on saving and investing, rushing to catch up late in our careers once the writing is clearly splattered on the wall like a Stephen King midnight foray?

The Dangers of Believing We’ll Never Retire

Perhaps we tend to overemphasize the notion that if we find something we love, we will truly never retire. A reader of this website recently recommended me the book Ikigai: The Japanese Secret to a Long and Happy Life, by Hector Garcia and Francesc Miralles. And like the faithful servant I am to my readers, I read it.

In this book, the authors note that in Japanese culture—more specifically on the Okinawa Islands—the concept of retirement simply doesn’t exist. It’s a worthy book: Check it out.

There is little in the Japanese language that conveys the concept of stopping work completely. And certainly, this idea works: the number of centenarians (those that are 100 or more years old) on the Okinawan islands is far beyond that observed elsewhere in the world. In fact, Okinawan women are three times more likely to reach the ripe old age of 100 than North American women.

This culture, and many like it elsewhere in the world, observe core tenants of a good life: staying active, adopting a slower pace of life, eating moderately and eating well, spending time in nature, and surrounding themselves with a wholesome community.

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How Will We Fund Our Later Years? Compound Growth

While I full-heartedly agree that the western concept of retirement is ridiculously flawed—sitting on the lazy boy and watching endless reels of Fox News and true crime dramas—I think we’re rolling the dice to assume that someone will continue paying most of us a livable wage beyond our prime working years. That’s not how our society is structured. I fully intend to work the rest of my life, but I would be (likely) wrong to assume that a livable paycheck will accompany that work.

And Social Security? Consider Social Security highly insecure, if not extinct, by 2035.  

As such, we face the great importance of saving and creating compound growth of our money…as soon as we can.

The Sweet-Ass Math Behind Compound Growth

What’s compound growth?

Well, there’s been this little virus circulating for a while now. Have you heard about it?

Let’s say Johnny goes to a bar and catches the little bug. Johnny goes home with his little bug and gives it to his wife Sally. He also passes the bug to his brother Jeremy, who lives on the couch.

Sally goes to work the next day and gives it to the entire four-member Accounts Payable department as they gather around her new hunky fireman calendar, foregoing social distancing to admire the bronze six pack on Mr. January.

Brother Jeremy simply shuffles across the street to his buddy Michael’s house, where he promptly infects all eight invitees after a drunken sing-along to Elton John’s Circle of Life (a classic Lion King ditty – YOU try not singing along!).

So, in this case, Johnny’s single infection ultimately leads to fourteen new infections! And as all these unfortunate infected souls continue to interact in the world, we can imagine the exponential growth in cases.

Compound Growth of Your Money

The good news is that properly investing your money (and not buying GameStop) tends to result in a similar, sustainable upward trajectory.

There’s a famous quote, often attributed to Albert Einstein (but isn’t every famous quote?), that goes something like this:

Compound interest is the 8^th wonder of the world. He who understands it earns it…he who doesn’t…pays it.

Quite Possibly Not Albert Einstein

Obviously, those who pay it are those who carry debt. Those who earn it are those who invest in sustainable appreciating assets (again, not GameStop).

Compound growth helps our money grow faster because we are accumulating growth in the market as well as our original principal (cost basis). As the original investment and the market returns grow together over months and year, the compounding creates a snowball effect. This snowball effect provides exponential growth to our savings.

A Compound Growth Investing Example

Let’s suppose I buy a share of stock for $100. If that share of stock rises in value 30% in a year (a killer year!), I now have a share worth $130.

Not very impressive, eh?

Now, if in the following year we experience another 30% growth, we don’t simply add another $30. We multiply the entire $130 by 0.30, add the result back to the $130 we started with, which gives us $169.

Still not impressed, are you?

If I just balled up that $100 two years ago, threw it at a stripper (Mrs. CC edit) musician, ran on stage and grabbed it, got kicked out by a beefy bouncer, and stuffed it back in my pocket⏤I’d still just have $100. I made an effortless $69.

A traditional saver who saves $10,000 per year will have $300,000 after 30 years (10,000 x 30). An investor who gains, on average, 7% yearly returns in the market will generate $1,020,727 with that exact same $10,000 yearly savings!

Inflation: Let Us Not Forget

It’s important to note that the traditional saver is falling even further behind than they may be aware. The forces of inflation result in the rising prices of goods and services each year, at about 2-3% per year. That’s why Coke no longer costs a nickel and why you don’t have to walk uphill both ways. So, $300,000 in 2051 will have a hell of a lot less purchasing power than it does in 2021.

To take full advantage of the snowballing effect, we need time.

Compound Growth! Great! I’ll Catch Up Later

Wrong. Compound growth is most effective when given the gift of time. To take full advantage of the snowballing effect, we need time. An investor with a $10,000 initial investment won’t be blown away by a 7% return in one year. That’s only $700. However, an investor with $1,000,000 invested—who’s been at this a while—will clear $70,000! It’s still the same 7% return, but my lady returning $70,000 just made enough in the market to pay for a hell of a lifestyle!

Let’s further note that the lady with $1,000,000 invested may only have a cost basis (her actual contributions) of say $500,000 or less. The rest is all compounded growth of returns in the market!

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Saving and Investing Now Vs Later

Sarah Saves and Invests for 40 Years: Retirement is Solid

Let’s suppose Sarah is 25 years old and just landed her first job in her new career. Sarah lives quite comfortably spending $25,000 per year. She pulls in $35,000 in salary, providing $10,000 in savings/investing opportunity.

Sarah is a sharp little ginger snap cookie, and she decides to put the entire $10,000 in her 401(k), dedicating 100% of her contributions to a low-cost and broad-based whole market stock index fund. She’s not able to max out her 401(k), but she’s doing great. She’s saving almost 29% of her income, which will likely reduce her required working years by well over a decade.

For whatever reason, Sarah never contributes more than $10,000 each year to her 401(k). I know that’s silly, but I can’t be bothered with a complex model and I think you’ll get the point here shortly.

By age 65, 40 years later, Sarah will have over $2,000,000 available to support her livelihood!

Over this 40-year interval, Sarah has only contributed just under $410,000. The long-term snowball effect of compounding growth provides Sarah with over $1.7 million dollars in gains, for doing nothing other than buying index funds.

If Sarah’s yearly spending has grown with inflation at 2% per year, she’s probably now spending close to $55,000 per year. If Sarah now retires and begins withdrawing on her investments, she has a meager 2.6% safe withdrawal rate, well within the coveted 4% Rule.

Verdict: Sarah is such a boss. Her retirement is secure, and she likely could have retired years ago.

Jeremy Saves and Invests for 30 Years: Retirement is Jeopardized

Fast-forward ten years.

Jeremy is 35 years old. After a decade of spending all or most of his $100,000 income, oh the times, they are a-changin’. He now has the same $10,000 per year to invest in his 401(k), a 10% savings rate. From a savings and investing standpoint: the only difference between Sarah and Jeremy is that Jeremy is starting ten years later, at age 35. His investment timeline to a traditional retirement is 30 years.

But will he be ready to retire?

Assuming Jeremey continues to invest the same yearly $10,000, Jeremy will have about $1,020,700 at age 65. While that sounds like a pile of cash, Jeremy has saved 52% less than Sarah over a 25% shorter investing timeframe.

Even though Jeremy made a much higher income, none of that matters. Everything is based on savings rate. All the fancy stuff, all the expensive travel, the big houses…the math is cold, unbiased, and is unimpressed with the money you spend. The math works on the money you save.

Jeremy’s nest egg of $1,020,700 will only support a sustainable 4% withdrawal rate of just over $40,000 per year. In 2061 dollars, Jeremy is kind of screwed, especially if he plans to continue spending $90,000 + inflation in retirement.

Verdict: Jeremy has not saved nearly enough to retire.

The Best Time to Start Investing is Now: The Compound Growth Snowball

I’ve said it a lot, and I’ll say it again. Time in the market, combined with a smart and sustainable investing plan (not GameStop) will very likely generate wealth to sustain you for your lifetime. With a more aggressive approach to saving, and maybe even a bit of luck, you can reach this milestone long before the traditional retirement age of 65.

Of course, all of this depends on faithful adherence to the plan.

¹ Retirement Security in an Aging Society

² CNBC: To Retire at 65, millennials will need to save nearly half of their paycheck

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