What is compound interest? And why does it matter?

It is the process of earning interest on your interest. Thanks to compounding, someone who is starting to save in their 20s is going to have significantly more money than someone who started to save the exact same amount in their 30s.

Here’s an example to explain further:

Take two friends: One starts investing $5,000 a year at the age of 25, and the other starts investing the same amount at the age of 35.

They both retire at the age of 65. The one who started earlier would have a net amount of approximately $1 million*, while the one who started at 35 would have a net amount of approximately $500,000*. This $50,000 invested over the years ($5,000 x 10 years) will translate to a difference of approximately $500,000 between the two.

*Assumes $5,000 annual contribution, 7% annual return.

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