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Millennials: Here's How Compound Interest Can Make or Break Your Future

    

SUMMARY: As a millennial, you have a huge leg up over earlier generations—time is on your side. Learn how compound interest gives you an advantage over your parents and older peers.

Millennials are credited (and blamed) for many things, but recent studies show that they are surprisingly good at saving. However, America’s largest generation—born between 1981 and 1996 and now 71 million strong—is not as swift at investing.

To be fair, millennials face immense financial pressure. Student loan payments, stagnant wages and soaring housing costs are just a few of the demands on their wallets. Combine that with a deep distrust of the markets, and you have a generation that is willing to save its money but unwilling to trust others to grow it.

Below, we explore the reasons that underpin millennials’ reluctance to roll the investment dice and delve into the two words that sum up why they should do it anyway—compound interest.

compound interest

Save? Yes! Invest? Meh ...

First, the good news: Yes, millennials save. In fact, 71 percent take advantage of their 401(k) or other workplace plan. And they start young—the median age is 24, earlier than their compadres in Generation X, who began at 30. In fact, 39 percent are “super savers,” stashing more than 10 percent of their annual income (experts typically recommend 15 percent). And one in six have an impressive $100,000 or more socked away.

Now, the cloudier outlook: Millennials, by and large, don’t invest. There are several reasons for this, but the 800-pound gorilla of them is the 2008-09 financial crisis. This generation came of age in the midst of a time when their parents and peers collectively lost millions, largely due to the reckless actions of those entrusted with investing their money. It’s not hard to understand why they would, therefore, be gun-shy when asked to put their precious savings in that same system.

The numbers reflect this skepticism:

  • 42 percent choose conservative investments (Gen X is at 38 percent, baby boomers at 23 percent).
  • 20 percent put their money in traditionally stable investments, such as cash, bonds or money market funds, compared to 15 percent of their elders.
  • A whopping 66 percent find investing scary or intimidating.

While millennials’ fear of the markets may be understandable, this anxiety has the potential to derail any possibility of a secure retirement.

Secure your future with our free retirement calculators »

A lost opportunity

Despite the risk involved, stocks are the missing link that can provide investors with returns large enough to fund a comfortable retirement. The S&P 500 posted an average 7.9 percent annual return from January 2007 through December 2017, compared to 0.3 percent for money market accounts. The ups and downs for stocks pay off over time, despite any fallout from a financial crisis.

Enter compound interest

When you boil the pro-investment argument down to its essence, it reduces into two simple words—compound interest. Compounding is when you earn interest on the principal amount you initially invested and also earn it on the past interest you’ve already accumulated.

Say you invest $100 in an account that earns 10 percent annual interest. After a year, your account will post $110. In the second year, that 10 percent interest is applied to the full $110, giving you $121. Each year, your interest rate applies to that previous year’s total, which can yield impressive results over time—after 10 years, that initial $100 will be $259.37. Invest $500, $1,000 or $5,000 at the outset, and compound interest quickly becomes your friend.

Put another way: When offered the choice of $100,000 in a lump sum or a penny that gets doubled every day for a month, go for the penny. Thirty-one days later, that penny will blossom into more than $10 million.

And millennials have another leg up over earlier generations—time is on their side. They can earn more compound interest than their parents or older peers. By contrast, cash that sits in a bank account is subject to inflation and increased costs of goods and services, so its value is likely to shrink over time.

Just get started

If investing seems as scary as peering over the edge of a 33-foot diving board to the tiny pool below, the easiest way to start is to just start. Take a deep breath and make the leap. The water will be there to catch you.

A good way to prepare for this new adventure is to take a step back and see what you will actually need for retirement. Our online calculator can be a helpful way to get your bearings and put the numbers in perspective.

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