Rein­vesting is key

The magic of compounding only bears fruit if you reinvest all the earnings back into it. Let your money run as long as you can. If you take it out too soon – either to spend it or move it to cash – you won’t get the full benefit of compounding. This is best seen by an example ..

Let’s say Joe plans to save and invest $1000 every year for next 20 years. The investment he chooses gives him 15% compounded return every year. If he sticks to his plan and does not withdraw any money from his savings, by Year 20 Joe will have amassed $136,600. Of course, if he had kept all his savings in cash, he would only have $20,000 in 20 years.

However, if Joe decides to withdraw 5% of his savings every year to spend, he will only get $67,258 by Year 20 – or about half as much as he could have. If he withdraws 8% every year, he will only have about 1/3rd the maximum amount.

So you see how just a seemingly small early withdrawal like 5% or 8% could make such a big difference in how much you end up accumulating over the years. The lesson here is particularly important for young savers who might have saved a tidy bundle in their early years but then couldn’t resist withdrawing and spending their wealth too soon.