Save early and often to harness the power of compound interest

In 1990, when I wrote my second book, More money, I have included a chapter called ”The Fairy Godmother and the Magic Train”. The aim was to illustrate the power of compound interest, and it told a fable about a good fairy who visits all new parents to tell them about a “train” that could lead the young child to riches.

The fare to take this train journey is only $2.83 per day ($1,000 per year) provided the parents start immediately: the payoff is that the child could have $3.8 million at 65 years old, the end of the journey. The figures are based on the assumption that the money is invested in quality equity trusts and that these trusts earn an average of 9% per year if all income is reinvested.

The story of a magic train is a good allegory for compound interest.

Boarding the “train” is free if they start paying the $2.83 per day from the day the child is born. However, as each year passes, its value increases as compounding works its magic. Thus, a person who delays the start of the program will have to pay an increasingly higher price to board the “train” if they wish to have the same amount at age 65 for an investment of only $2.83 per day.

For example, if you started the program when your child was born, the “train” might be worth $6,000 at age five, $16,000 at age 10, $62,000 at age 21, and $152,000 at age 30. “cost for anyone who wants to join the program later.

The story does more than demonstrate the magic of compound interest – it also shows the enormous cost of delay. Suppose Steven has put off investing that $2.83 a day, but sees the light at age 21, after discovering that Mary, whose parents started investing for her at birth, has accumulated $62,000. If Steven wants to keep pace with Mary and reach nearly $4 million by age 65, he’ll have to invest $600 a month for the next 44 years – that’s $317,000 – it all cost him (and his parents ) $65,000.

Now you might think this is all very academic, but let me give you a real life study. My eldest son was born in October 1981 and will be 36 this year. I could have easily afforded to invest $2.83 a day for him, but like most parents, I didn’t have the time to do so.

When I did the numbers, I found that if I had started the strategy when he was a newborn and the investment matched the accumulation index of all ordinaries, he would now be $305,000 – for an expense of $35,000.

To find out what would happen if someone in your family adopted my $2.83 a day strategy, just go to my website and click on “stock market calculators – dollar buy average” . You can then enter any start date since January 1980 and a theoretical annual investment. The calculator will tell you what you would have had on any date you choose to insert.

This naturally raises the question we all need to ask ourselves: why not launch these programs? Probably because deep down we all have an active impatience gene that makes us resist any course of action whose results only appear over time. It is easier to choose a severe diet “lose three kilos in seven days” than a diet that requires a slight adjustment in our eating habits and that will make us lose 12 kilos in 12 months.

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