Every year, families and friends celebrate students who are graduating from colleges and universities. Parents beam with pride at their children’s accomplishments and exhale in relief now that the tuition bills have finally stopped. It’s a time when adults give a lot of advice, which is why I have one simple idea I want to pass along to this year’s graduating class that I hope you never forget. Parents, take note too, because with college out of the way, you can get back to focusing on retirement.
In case you didn’t come across this idea in an econ class, let me explain compounding simply. It’s the process by which the value of an investment increases over time as earnings or interest are reinvested. It’s the snowball effect but with money. Here’s an example.
If you’re a US investor and lucky enough to have up to $35,000 left over in your 529 college savings plan, you can roll it over into a Roth IRA starting in 2024, provided the account has been open at least 15 years.1 If you don’t touch that $35,000 for 50 years, and the market averages a 10% annualized return, which is close to its long-term historical average, then guess how much you’ll have?2
The answer is C. Over $4.1 million!
If you were to start this in your mid-20s and invest that same initial amount for only 45 years, you’d end up with B, or $2.6 million. That’s great, but not as great as C.
If you do it for 40 years, you’ll end up with A, or $1.6 million. Also good, but, you know, not C.
Another benefit of compounding is that it can help you pursue financial goals along the way, like making a down payment on a home. But don’t worry if you spent your whole college fund or took out student loans. Start with a little and get in the habit of adding when you can. As you can see from this snowballing, having a lot of time can help make up for not having a lot of money.
1 Laura Saunders, “Your Child Picked a College! Tee Up Your 529 Plan,” Wall Street Journal, May 5, 2023.
2 In US dollars. Based on S&P 500 Index annual returns, 1926–2022. S&P data © 2023 S&P Dow Jones Indices LLC, a division of S&P Global. All rights reserved. Indices are not available for direct investment; therefore, their performance does not reflect the expenses associated with the management of an actual portfolio.
Adapted from Let the Compounding Commence! by Dimensional Fund Advisors LP.
Past performance is not a guarantee of future results. Indices are not available for direct investment. Their performance does not reflect the expenses associated with the management of an actual portfolio.
In US dollars. Growth of wealth shows the growth of a hypothetical investment of $1 in the securities in the S&P 500 Index. S&P data © 2022 S&P Dow Jones Indices LLC, a division of S&P Global. All rights reserved. Data presented in the growth of wealth chart is hypothetical and assumes reinvestment of income and no transaction costs or taxes. The chart is for illustrative purposes only and is not indicative of any investment
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