Is Compound Interest Overrated?

On this week’s podcast Michael and I touched on two personal finance topics that are important for everyone, but especially young people:

(1) The more money you make, the more money you spend.

(2) The gains from compounding are back-loaded

Here’s the video:
 


 
Towards the end of this clip I mention how the majority of the gains from compounding tend to come at the end. This is one of the things that makes compounding equal parts amazing and maddening.

Michael responds, “If 90% of your wealth comes after age 80, I can’t get excited about that. I think compounding is overrated.”

My co-host was being a tad facetious here but his point stands. It’s true you need many decades to allow compounding to do most of the heavy lifting for you.

Buffett has made something like 95% of his wealth after age 60, to which most normal people would reply, “That’s a long time to wait to enjoy myself.”

Although Michael was half-joking when he called compound interest overrated, I think the nature of compounding makes it even more important for young people to start saving as soon as possible.

If it potentially takes many decades for compounding to pick up the slack, the sooner you begin saving the better. That means you’ll begin seeing the benefits sooner than those who put it off until later.

And even if you can’t set aside a ton of money right away, simply building those habits from a young age can be helpful. The longer you wait the harder it’s going to be.

If losses feel twice as bad as gains feel good, it’s only going to get harder to set aside money from your paycheck as you age. The sooner you begin paying yourself first in the form of savings, the easier it will be to avoid missing that money and having loss aversion kick you in the teeth later in life.

Saving money is not easy when you’re young.

But it can be even harder to begin when you’re older because the more money people make the harder it can be to let go of their spending habits.

Plus the impact of compounding is more muted the later you start saving money.

Further reading:
Is the Ford F-150 Partially Responsible for the Retirement Crisis?

Now here’s what I’ve been reading lately:

 
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