From an early age, many of us learn to save. If you were like me, you had a piggy bank or a coin sorter and roller. I had both. It is amazing how much loose change can add up to so many dollars!
The difference between a piggy bank and a 401k is the self-reinforcing force that is called compound interest. Simply put compound interest is your savings earning savings; it is your interest earning interest.
Like most forces in life there is a mathematical formula associated with compounding. The growth in your 401k portfolio is a result of three factors.
- Time (the sooner the better)
- A positive return (the bigger the better, C-lect matters)
- A start and ongoing contribution (meet the match and maximize the contribution)
Time relates the most to the compounding equation. Einstein said “Compound interest is the eighth wonder of the world. He who understands it, earns it … he who doesn’t … pays it.” So, we suggest you take advantage of this force sooner rather than later because of the significant results compounding interest will have on your 401k portfolio.
At 401k Selections we are here to explain and reinforce this wondrous concept, so you can understand the power of time on compounding return in your 401k. Before you decide to spend or go into debt, instead of saving first and meeting the match and maximizing that contribution, consider the example in the column to the right of how time significantly impacts your ending portfolio. The earlier you start the better off you will be. It is all about “capturing” the compounding periods to your benefit.
For the remainder of this column, I want to look at the uncontrollable factor. Of the three variables, we can control two. We can control when we start and how much we save, but we can’t control the return we make.
Lack of control is not to say complete lack of control. This is where the C-lect rotation strategy comes into play.
As seen in the 401k back tests and summarized on page three, proactively investing along the efficient frontier where returns are maximized and risks are minimized should help over the years. In fact if you are “late to saving”, this variable will be even more of a critical factor moving forward.
Obviously, the more you save, the earlier you start, the better. The more you earn is also better. It is all the more reason to “stay with the leaders and avoid the laggards”. *