When you are young and are looking to begin your retirement plan, you will often hear of the power of compound interest. While there are many descriptions and numbers and formulas that you can find online, we want to look at a basic description of what compound interest is first.

When you talk compound interest, you are talking about money that makes money which makes more money. Sounds strange, right? Consider this. Take 7 pennies (for ease of calculations), one for each day of the week. Now, lets call your dresser or hutch the “Bank”. Each day when you wake up, you will place a penny on this dresser. Now after 7 days you know you will have at least 7 pennies invested.

Now the Bank takes this money and invests it in loans and other ways to make money. They charge a higher interest rate on those loans than what they pay you for your deposits. However, in this one week, you have made 3 pennies in interest. You now have 10 pennies.

Now, compound interest kicks in. Your original 7 pennies has now turned into 10 pennies. So if you keep investing a penny a day and you keep earning interest, you will have deposited 365 pennies in a year. Now instead of 3 pennies per week interest, lets say that you earn 10 percent interest on your money. You might think you calculate it on the total for the year.

Wrong!

This is compound interest we are talking about! So, you are earning 10 percent a month. So during month one, you have invested 30 pennies. You earned 3 in interest. In the second month you deposit another 30 pennies. You now have 63 pennies that you are earning interest on, so you have earned 6.3 pennies. The third month you deposit another 30 pennies. You are now up to 96.3 pennies and have earned 9.6 pennies interest.

See how this can grow? Let’s look at a real life example.

Let’s look at a simple, one time investment of $5,000. This is not an ongoing type of investment and only a single long term investment for 30 years. Let’s assume three different rates of return on our investment, 2%, 6% and 12%. These are rather realistic rates of return on investments these days, especially in 401k and Mutual fund investments.

While the $5,000 investment at 2% interest isn’t much after 30 years, the 6% rate of return will grow to around $30,000. At the 12% rate of return, it will have grown to around $180,000!Which would you rather have at retirement? The $30,000 or the $180,000? The rate of return makes a huge difference. The power of compound interest can help you attain all your financial goals more easily than you may think.

Here is another example that shows the power of compound interest. How would you like to turn $33,500 into $4 million? Start an IRA for your child when he or she is born. A $500 contribution every year (less than $50 per month) for 67 years (a total contribution of $33,500) at a 10% rate of return will give your child about $4 million at retirement! Waiting until your child is 21 to start saving will reduce this value at retirement to $500,000!

I hope these retirement planning tips help you to understand a couple of key facts about compound interest. First, don’t wait to invest!!! Compound interest works best over time! Secondly, keep investing at any age! Some people think they are too old to invest. This thought will cost you money!