Saving: The Keys to Success

By: Source: AARP.org Date Posted: 2006-04-13 15:38:31.929093-04:00

Pay yourself first. Although you may find it difficult at first, the key is to pay yourself first. It is a great way to get in the habit of saving. Before long, you will be very happy that you are saving and paying yourself first, not last.

Do it automatically. Pay yourself first automatically. It's easy to do electronically. Simply have a certain amount from your paycheck deposited into a financial account. You'll complete a form authorizing your bank (or whatever institution) to receive a portion of every paycheck and deposit it into your savings account. This is a great way to build up your savings—if you don't see the money, you won't miss it.

Save 10% of your paycheck. A good rule of thumb is to save 10% of your paycheck. If this feels too high, try 5% for a while. Then, try to work up to saving 10% of your earnings. You'll thank yourself over and over for doing it, once you've retired.

The power of compound interest. Not all investing strategies are complicated. Perhaps the simplest strategy of all is to just leave it alone and let it accumulate over time, or "compound."

Thanks to the power of compounding, the more money you save, the faster it grows. That's because you earn interest not only on what you save, but also on the interest generated. The earlier you start to save, the more dramatically your money can grow.

Example: Let's say you start out with $100 and it earns 5% compound interest. When your interest is compounded, the bank takes the interest that your account has earned during the previous day, week, month, or year. It adds that interest to your principal and then calculates your new interest payment. If you receive 5-percent compounded interest on a principal of $100, your investment would grow like this:

Year 1: $105.00
Year 2: $110.25
Year 3: $115.76
Year 4: $121.55
Year 5: $127.63

Doubling Your Money—The Rule of 72

How long will it take for your investment to double with compound interest? To find out, use the Rule of 72. Divide 72 by the interest rate you expect to receive on an investment. For example, if your investment earns 6 percent interest, your money will double in 12 years (72 divided by 6 equals 12).

At an interest rate of:	Your investment will double in:
3%	24.0 years
5 %	14.4 years
7%	10.3 years
10%	7.2 years
12%	6.0 years

Time Is Money

If you save on a regular basis, your dollars work even harder for you if your interest is compounded. The chart below will help you determine how much one dollar, invested today, will be worth when you retire.

Value Over Time of $1 Per Year Accumulated at Various Interest Rates
Interest Rate*	Years
	5	10	15	20	25	30	35
4%	5.42	12.01	20.02	29.78	41.65	56.08	95.03
6%	5.64	13.18	23.28	36.79	54.86	79.06	154.08
8%	5.87	14.49	27.15	45.76	71.11	113.28	259.10

*Interest compounded annually

Take Action

Figure out how much you should have available in case of an emergency .
For an easy way to see how much compounding improves your nest egg over time, try the calculator at www.moneychimp.com/calculator .
Get more information from the AARP series Money Matters .