Time plus Compound Interest is Super Important

The Importance of Time

The market dipped lower this past month, which makes for a lot of scary headlines, but a dip should be seen as a buying opportunity for us young people. Most of the money we're investing now has a time horizon so far away that any market dip is a fine time to buy, as long as we're talking about diverse holdings like index funds or blue chip stocks.  

To illustrate this point, see the image below that I copied from a 401k retirement account enrollment. It's a simple but effective illustration comparing three people who save the same amount toward retirement each month but start saving at different ages. As you can see, the blue line, which shows someone who started saving for retirement at age 25 (hint hint everyone close to this age) has $1.6M in retirement savings at age 70. This is double the $800k figure of the orange line person, who only started saving for retirement at age 35. This assumes that each of the three people invests in the same thing -- the key difference is the time invested. Perhaps the moral of the story here is that while it is definitely tempting to buy a $400 Dyson hair dryer when you get your first check from your first job, that same money will multiply and compound like magic if you invest it. That is even more true if that money is invested in tax-friendly retirement accounts. So let's do some Math like Andrew Yang would -- what do you think that same $400 at age 22 would be at age 70?

Math is so Scary ahhh!

The way to calculate what $400 will turn into is to use the compound interest formula. Compound interest (instead of simple interest) just means that any investment returns you make over time also will make you money. It's easy to explain with an example. $100 with 10% simple interest over 5 years is $150. You are getting $10 each year, because the interest isn't compounded. With compound interest, $100 with 10% compound interest over 5 years is $161. Why? because each year, instead of the 10% working against the $100, it's working against $110 after year one, $121 after year two, etc. That's compound interest. You can use compound interest to forecast any investment holding appreciation, e.g. calculating what the price of Apple will be in 5 years, assuming it increases 20% each year.

Let's go back to our $400 Dyson hair dryer. Remembering algebra basics tells us that exponents have the most 'power' to change the result of an equation. Putting this in the context of the compound interest formula below, the way to maximize your investment return is to maximize what's in the exponent of the formula. More times compounded (like monthly interest instead of yearly) or more time invested are the two most powerful variables, keeping all else equal.

What do you think that Dyson hair dryer money would be worth invested over the 48 years between ages 22 and 70? I'll spare you the tedious Perrone-math-standard new line for every calculation and instead use everyone's favorite compound interest online calculator, on a website called MoneyChimp. Assuming a 10% annual return on $400, that money would grow to $38,806 by the time that the 22-year-old turns 70. Crazy, right? If we factor in inflation, then that figure will start to look a little less impressive, but that's a different topic for a different day.

Trades

• Nick sold 2 shares of Microsoft (MSFT) and bought 5 shares of Chewy (CHWY). Both Connor and Chloe are back positive this month -- everyone is over $1000! (Milena still needs to update the sheet)
  

Please remember to update the google sheet detail tab when you buy/sell something. I look at the revision history each month so I can include your trade in this newsletter. The summary tab is at the bottom of this email as a picture and the live link to it is here.