Compound Growth

Compound interest: The 8th wonder of the world We show you the power of compound interest and how to visualize projected compound interest on your Betterment accounts. In this article, we show you the power of compound interest and teach you how to use our tools to see how your investing accounts may grow over time. The main idea: Compound interest is when your earnings from investments are reinvested, growing even more earnings or “compounding” over time. It’s one of the ways your savings grow. How it works: Don’t worry, we won’t get into the complicated math. Let’s look at a scenario instead. But first, we need to know that three things go into creating value with compound interest: Rate of return on your investment or savings. Usually listed as a historical annualized return for stock investing or an annual percentage yield (APY) for savings and cash accounts. Frequency of compounding. For stock investing, this means how often you earn dividends and for a savings or cash account, this means how often you are paid interest. Time period for which your money is invested. The longer this is, the more time your money has to compound. Now let's look at a hypothetical scenario. Pretend two people each have $5,000 of savings. Over a five-year period, from August 2018 to July 2023, they each manage their money differently. Person 1: Keeps the $5,000 in a checking account that earns 0% interest. They still have $5,000 in July 2023 because there was no chance for their money to experience compound interest. Person 2: Invested $5,000 into an investing portfolio on August 1, 2018. With dividends reinvested, they averaged 7.4% annualized returns after fees, and on July 31, 2023, their account was worth $7,145. Compounding works the same way in savings or cash accounts that pay interest. For example, our Cash Reserve account allows you to earn a variable rate APY to compound your savings. You generally pay taxes on earnings in both investing and cash accounts, but even with taxes, your money has the potential to grow over the long term due to compound interest. Visualize compound interest on your Betterment investing account: Our mobile app and desktop platform both offer simple tools to help you see how compounding could impact your goals. Mobile app: Navigate to your investing account and view the Projection graph to see a visualization of how your account may compound over time. Desktop platform: To use the goal forecaster, navigate to your investing goal. Select the “Plan” section, then click the “Open goal forecaster” button. Our goal forecaster tool allows you to enter scenarios for deposit and target date inputs. The projection graph will show you the estimated impact of compound interest on your investment portfolio along with the chance of reaching your goal based on your inputs.

Why saving for your retirement isn’t a solo climb And the summit is smaller than you think Figuring out how much you need to retire can feel like an exercise in futility, primarily because of two reasons: It’s a moving target. Our needs and, by extension, our spending changes as we age. It’s a Very Big Number. And Very Big Numbers can seem so far out of reach. So let’s simplify things for a second. We’ll share a way to quickly crunch your retirement savings number, how to make it seem less scary, then demonstrate how we do things in the Betterment app. Revising the 25x rule This popular shorthand says to multiply your annual expenses in retirement by 25 to land on your number. It’s the inverse of the 4% rule, another quick calculation for how much of your investments you can sustainably spend each year. They're both ballpark numbers, and if you’re in the early or even middle stages of your financial journey, they can be helpful. But the 25x rule has a hitch, and it’s the challenge of knowing exactly how much we’ll spend in retirement. Luckily for us, we can approximate these shifts by looking at our fellow Americans’ average spending levels by age. When we do that, we see that our spending tends to peak in middle age and declines as we approach the traditional retirement age of 65. In short, you’ll likely spend less in retirement than you do now. And that’s good news! It means you probably need less than you think to retire. So take your current spending—that’s pre-tax income, minus taxes, minus retirement saving—and adjust depending on when you want to retire before multiplying by 25. That’s your age-adjusted retirement savings number, roughly speaking. Now let’s make it seem less like Mount Everest. Because we’ll let you in on a little secret: (You don’t need to save the entire amount) As an example, we’ll make your Very Big Number a Nice Round Number, too. Say you need roughly $2,000,000 for retirement. Using the 4% rule, that’s $80,000 of spending each year. Seeing that many zeros in a savings goal can be demoralizing. But what if we said you weren’t on the hook for all of it? That a generous friend was more than willing to help. And not only help, but shoulder the majority of the load. They just work slowly, so you’ll need to be patient. Your friend, as you may have guessed, is compound growth. And you may be shocked by their share of your retirement savings. Assuming you reach your goal in 30 years, saving $2,500 a month and earning a 5% inflation-adjusted annual return, here’s how much you would have directly saved, compared with how much your “pal” chipped in. You read that right. In this scenario, compound growth is responsible for more than half of your retirement saving. Sticking with our Mount Everest metaphor, that’s like a sherpa giving you a piggy-back ride not long after leaving base camp. Now, don’t get us wrong—$900k is not nothing. But it certainly sounds more doable than $2 million, doesn’t it? And that $2,500 saved a month? That just so happens to be 2024’s combined maximum contribution for a 401(k) and IRA. Either way, it’s best to not dwell on a Very Big Number for too long. Back-of-the-napkin exercises such as these serve a purpose, to a point. So our retirement planning advice, along with adding way more nuance to your calculations, encourages you to focus simply on your desired annual spending in retirement. We help you chart a course to get there and automate your approach, all so you can forget about finances for a second. Because compound growth grows the fastest when you’re not looking.