Imagine this—Jonny High Schooler was sixteen years old when he landed a summer job at the local grocery store. He worked hard and was able to save $2,000 during the summer months. Now, what did Jonny High Schooler do with this money? Did he spend it all going out to eat? No. Did he buy a bunch of new video games? Nope. What did he do?
He put it into a retirement account and invested it. He did the same thing for the next two summers at ages seventeen and eighteen. Over three years, he put $6,000 into a retirement account and invested it. But that was it; he didn’t put any more money in there.
Not at all.
Let’s assume that Jonny High Schooler invested in a fund that mirrored the total performance of the S&P 500 (a benchmark for the U.S. stock market performance) from 1969 to 2018. (I’ll explain some of these concepts in a second). Before Jonny High Schooler leaves for college, what has he done?
Check out the chart to see.
Note: Chart assumes annual return, including dividends.
Not bad for a summer job. Jonny High Schooler have himself $672,000 for retirement by setting aside $6,000 prior to college. And what if he developed a habit of setting aside $2,000 each year? Jonny High Schooler would be a millionaire by age sixty-five.
And any teenager can do this.
How does this work? Compounding.
Compounding is a pretty simple concept. The percentage you earn each year is placed on the principal (the amount you set aside). So, the next year, your gain is not just based on the original amount, but the total amount of principal plus whatever increases you had. Over time, big time growth can occur.
Here’s a quick example—If you have $100 and earn 10 percent in year one, you end year one with $110 (10% of $100 is $10). Then let’s say you earn another 10 percent in year two. Since you started year two with $110, the 10 percent gets you $11 ($110 x 10%). So you end year two with $121. Over time, a 10 percent increase will give you a larger and larger gain.
That’s compounding. And here is what it means:
A little bit of money + A lot of time = A lot of money
Charts, like the one you just saw, are illustrations to demonstrate the power of starting early, and future numbers aren’t guaranteed to be the exact same. Investments fluctuate in price. Some years they are up, and some years they are down. But the point remains—start now, start now, and start now.
Teenagers have a really big opportunity to make a big difference because of their age. And I guarantee you that their parents wish they could go back in time and start their retirement account when they were teenagers.
Is it abnormal for a teenager to save for retirement?
But this is a good kind of abnormal.