Life seems to get a bit easier when you're proactive about things instead of reactive. That goes for your health, career, relationships, and finances.
Being proactive is especially important when it comes to saving for retirement because playing catch-up at the last minute isn't feasible for most people. It often takes decades of consistent saving and investing.
Even with decades of saving under your belt, there are tricks that can accelerate the process. One such trick is to lean on and embrace compound earnings.
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Letting compounding work for you
When it comes to saving and investing, the compounding effect is the key to building wealth and your retirement nest egg. To see it in action, let's imagine that you invest $10,000 and earn 10% on that investment annually.
Below is how your investment would play out after 10 years.
| Year | Investment Value at the Start of the Year | Annual Earnings | Investment Value at Year-End |
|---|---|---|---|
| 1 | $10,000 | $1,000 | $11,000 |
| 2 | $11,000 | $1,100 | $12,100 |
| 3 | $12,100 | $1,210 | $13,310 |
| 4 | $13,310 | $1,331 | $14,641 |
| 5 | $14,641 | $1,464 | $16,105 |
| 6 | $16,105 | $1,611 | $17,716 |
| 7 | $17,716 | $1,772 | $19,488 |
| 8 | $19,488 | $1,949 | $21,437 |
| 9 | $21,437 | $2,144 | $23,581 |
| 10 | $23,581 | $2,358 | $25,939 |
Calculations by author. Values to the nearest dollar.
Compounding occurs when the gains you earn on investments begin to earn gains in turn. In this scenario, your investment grew by over $15,900 by letting compounding work its magic.
Had you banked the $1,000 you earned on the initial $10,000 investment each year, you would have only earned $10,000 in those 10 years. That means you earned over $5,900 more in those years by doing nothing other than letting your capital sit and continue to grow. That's the power of compounding.
Don't settle; keep contributing to fuel compound earnings
Investing for retirement is all about consistency through both up and down periods. Accomplishing a million-dollar retirement portfolio is a milestone for many people, but it's virtually impossible to do by strictly saving. Even if you could put aside $25,000 per year, it'd take 40 years to hit $1 million.
In the above example, a one-time investment was made. However, compound earnings work best when you continue to contribute. For perspective, imagine you have $1,000 you can invest monthly.
By investing $1,000 monthly and averaging 10% annual returns (the historical long-term average of the S&P 500), your portfolio could reach over $1.06 million in 24 years while you only invest $288,000 in that span. That's over a $770,000 difference with virtually no extra work on your part.
Dividends can work wonders in boosting your savings
I always encourage investing in dividend stocks for retirement because they provide guaranteed income (in most cases), and you don't have to rely on stock price growth to make money. You can't predict how stock prices will move because they're often irrational, but you can count on your quarterly or monthly dividend if you're investing in quality dividend stocks.
Aside from investing in dividend stocks, a key to adding a spark to your retirement savings is utilizing a dividend reinvestment plan (DRIP). In a DRIP, your brokerage platform automatically reinvests the dividends you receive into the stock or fund that paid them out.
For example, if Stock A pays a $1 quarterly dividend and you own 50 shares, instead of receiving $50 in cash, you'd essentially receive $50 worth of Stock A.
Using a DRIP can boost the effects of compound earnings by increasing your shares in a company, which increases the amount of dividends you're paid, which then gets reinvested to buy even more shares -- further accelerating your growth. It's a lucrative snowball effect.
Ideally, you would use a DRIP to increase your shares until you hit retirement and then begin taking your dividends as cash.
