A famous investor, Charlie Munger, declared, “The first rule of compounding: Never interrupt it unnecessarily.” One of the reasons you’re encouraged to start saving and investing as young as possible is because several decades of uninterrupted compounding can cause your retirement accounts to significantly increase even if you are no longer contributing to them. Albert Einstein once said, “Compound interest is the eighth wonder of the world. He who understands it, earns it; he who doesn’t, pays it.”
To illustrate the power of compounding, a 2021 report by Vanguard showed the average 401(k) balance for individuals between ages 45 and 54 was $161,079. If a 45-year-old averaged an annualized return of 7% over the next decade, when they are 55 years old, their 401(k) balance would have nearly doubled to $316,866 even if no contributions were made to the account! If the same 7% return continued until age 65 without any contributions or distributions, the balance would have nearly doubled again to $623,324!
While compound interest can take a long time to make a meaningful difference in an individual’s life, if retirement funds are consistently withdrawn while working, then it will be harder for retirement balances to grow.