The Magic of Compounding with Jack and Sally

Why is it important that an investor begin investing early in their lives? Richard Russell (1924-2015), one of the most influential financial writers of modern times, gives a convincing answer with the hypothetical story of Jack and Sally.

At 19, Sally makes the decision to open an IRA account. She invests $2000 annually until she turns 26. After this seven year period, she stops contributing to the account. Jack, also 19, starts contributing $2000 a year to his account at age 26, continuing to do so until he reaches age 65. Let’s assume the IRA gains an average of 10% (7% interest plus growth), who do you think has more money for retirement at age 65? Jack or Sally?

The absolute amount is $29,063 – Jack with $973,704 and Sally $944,641, or Jack with 3% more. But who really won? Well, Jack invested $80,000 while Sally only invested $14,000, so the return on their principal is 12,000% for Jack – great! – but 67,500% for Sally – astounding! Although Jack invested 33 years longer and $64,000 more than Sally, Sally clearly beat Jack when you look at the returns.

So what’s the lesson here?  

Compounding – start early – let the returns compound and work their magic. A little savings and a lot of time is all you need to have a nice nest egg.