Savings Vs Compounding, Which is More Powerful?

[Retire52]

Einstein said, to paraphrase, 'Compounding is the most powerful force in the universe.' When I went through my financial records a couple years ago, when I'd just reached RE, I noted my savings contributed 56% of my NW and interest on investments represented the remaining 44%. I added the equity on our home to the savings side as the home value only kept up with inflation.

I started saving and investing right out of college. Unfortunately, not as much as I would have liked during the first half off my 30 year w*rking career, but increased the savings rate until it reached its zenith of 40% of after tax income for several years in the latter half of my w*rk life. Maybe, if didn't have such a steep learning curve of picking individual stocks til I got wise to index funds, my compounded interest earnings would have beat savings.

Post RE, I certainly agree with Einstein's statement! Living on passive income sure beats a poke in the eye :-)

I'm just curious if anyone else bothered tocheck to see how much they saved vs how much they earned on interest and what the break out was for them?

[pb4uski]

I haven't bothered but you can get a fair idea with a little math. Let's say that you saved $100 a year for 30 years and those savings earned 5% annually. At the end of 30 years your $3,000 of contributions would have grown to $6,644 at 5%... and $9,446 at 7%.

[Sunset]

I am wondering about OP math choices.

OP didn't count the home value increase as it only kept up with inflation, so did OP also discount the investment "interest" by the inflation factor as well ?

I've often wondered about the compounding belief, and how much of it is overestimated. Example if $1.00 invested goes up by inflation every year for 30 years, it looks bigger, but still can only buy the same amount of bread as 30 years ago.

[pb4uski]

Quote:

Originally Posted by pb4uski I haven't bothered but you can get a fair idea with a little math. Let's say that you saved $100 a year for 30 years and those savings earned 5% annually. At the end of 30 years your $3,000 of contributions would have grown to $6,644 at 5%... and $9,446 at 7%.

Quote:

Originally Posted by Sunset .... I've often wondered about the compounding belief, and how much of it is overestimated. Example if $1.00 invested goes up by inflation every year for 30 years, it looks bigger, but still can only buy the same amount of bread as 30 years ago.

It's quite easy to convert the example from nominal balances to real balances by simply reducing the accretion rate by the inflation rate.... if inflation was 3% then the real rates would be 3% and 5%, respectively and the balances at the end of 30 years would be $4,057 and $5,608, respectively.

[Gumby]

I haven't done the calculation posited in the OP, but I do recall when I realized that the increase in my portfolio balance for the year was driven more by investment growth than by my contributions for that year. That was the point on my FIRE journey when I could finally see the light at the end of the tunnel.

[Retire52]

Quote:

Originally Posted by Sunset I am wondering about OP math choices. OP didn't count the home value increase as it only kept up with inflation, so did OP also discount the investment "interest" by the inflation factor as well ? I've often wondered about the compounding belief, and how much of it is overestimated. Example if $1.00 invested goes up by inflation every year for 30 years, it looks bigger, but still can only buy the same amount of bread as 30 years ago.

Good catch. As I tried to discount for inflation, I realized most of my investment interest earnings (roughly 80%) occurred after 08 great recession, so from 2008 to 2017, inflation was 14%. So, the discount would have been something less than this since I was still adding savings each year. Therefore, inflation didn't move the needle significantly.

[Retire52]

For me I had a similar moment the year I earned more from interest than I did during one particularly hot summer in college when I worked 3 jobs, one of which was cutting grass on campus, and managed to save $3,500.

Quote:

Originally Posted by Gumby I haven't done the calculation posited in the OP, but I do recall when I realized that the increase in my portfolio balance for the year was driven more by investment growth than by my contributions for that year. That was the point on my FIRE journey when I could finally see the light at the end of the tunnel.

[RetireAge50]

We saved about 20% of our income during our working years or about $650,000. Our portfolio is now over $2 million. The compounding would never happen without the savings but it really takes off eventually.

[FI_RElater]

In early years, the amount of savings dominates. As this forum is of "early" retire... it also stands to reason that compounding wouldn't have the same level of consideration vs those who retired at "normal" timeframes.