Ep 03: The 8th wonder of the world… compound interest!

Episode Transcript

Intro/Close: 0:03
Welcome to the Real Talk Retirement Show, where we explore the financial side of retirement and beyond. Whether you’re currently retired or planning for the future, we offer real, relatable conversations about money and personal finances. Most importantly, we dive into all these topics using Real Talk. Now, let’s get real about your money and your retirement. Now, let’s get real about your money and your retirement.

Brian Graff: 0:28
Hello friends, colleagues, loyal listeners, hi Mom Just kidding, my mother has no idea what a podcast is, but we are Brian Graff and Tracy Burke from Conrad Siegel, back with you for another episode of the Real Talk Retirement Show. This is episode number three, and delighted to be in front of you again today, tracy. Today we’re going to talk about something that’s so awesome, amazing, right, it’s one of the most powerful concepts in all investing, which is why it’s sometimes called the eighth wonder of the world, at least in investing circles. Any idea what I’m talking about, tracy? Today I think we’re going to be talking about compound interest, right, brian, ding, ding. I don’t know if we have an audio clip to go along with that bell ringing, but yes, tracy, you’re correct. Compound interest Super, super important. We think that it’s probably the most important concept that long-term investors need to be aware of and without further ado, tracy, let’s get right into it. Can you explain to our listeners a little bit more about what compound interest is and why it’s so important?

Tracy Burke: 1:34
Yeah, for sure, because most folks have heard the terminology before, but like a lot of other jargon that might be in the financial services field, sometimes you think you know what it is, but let’s just break it down in a very simple concept. It’s basically you’re making money on the money you make, right? So, as an example say, you have $1,000. You invest that. You earn 5% in a year. At the end of that year you’re going to have $1,050. The next year now you’re going to be earning interest not only just on the if you still have 5% interest. You’re not just going to be earning interest on that 1,000, but you’re going to be earning interest on the 5% you earned the year before. That’s the compounding of effects. So it really snowballs as time goes along. So when investing, that certainly works on your favor. Besides just earning on what you’re putting initially all the earnings you’re going to be earning money on that as well.

Tracy Burke: 2:39
Now, on the other hand, if you have debt, if you’re paying loans, especially credit card debt, it can actually work against you because that same concept if you have interest that’s accumulating or accruing, you’re actually paying interest on the interest. So it can work the opposite way, while it’s magical on the investment side? It’s not magical, it’s the complete opposite on the other side. For credit card debt in particular, mortgages are almost always simple interest, so that doesn’t apply in that case. But some of the less favorable debt and at some point we’ll talk about debt in future shows. But I just want to point out it’s good for investing, not as good on the debt side. Especially depends on what type of debt.

Brian Graff: 3:23
Sure, great point, tracy.

Brian Graff: 3:24
We will focus on the good side of it today. We’ll think about saving and investing. And, tracy, I think it’s pretty safe to assume that most of our listeners have heard the name Warren Buffett. Yeah, not to be confused with the late great Jimmy Buffett, the musician who’s probably enjoying his cheeseburger in paradise, washing it down with a boat drink up in Margaritaville above. Shout out to my Uncle Phil and Aunt Ruth, who are both parrot heads. But anyway, back to Warren Buffett. If you’re not familiar with him, definitely Google him. But Warren Buffett is generally considered to be one of the greatest, if not the greatest, investors of our lifetime.

Brian Graff: 3:59
And, tracy, did you know that 99% of Warren Buffett’s net worth occurred after age 65? That’s crazy, right? And he’s turning 95 this year and has been investing for roughly 75 years. So why was all this wealth so late in life Compound interest, right? So I think, while Warren Buffett was widely known for his skill in investing, the secret sauce or the secret formula really was just time Time being on his side and letting that interest compound on top of interest on top of interest, like you were alluding to earlier, tracy, and that snowball effect. A great quote, and I want to make sure I read this right from Warren Buffett is that my wealth has come from a combination of living in America, some lucky genes and, of course, compound interest. So pretty, pretty telling stuff right there.

Tracy Burke: 4:52
Yeah for sure, and time matters, right. In this case, certainly time does matter and, like you just said, this is exciting because it really does work. So let’s do a couple examples here. Brian, to sort of drill this down a little bit, is better than starting later, right? And we’ve heard that all along. You’re better off at starting at at 22 versus 32 or 42 or 52, right? So we’re going to use an example, and we have two folks, jane and jim. Apologies to any you know couples out there that are named jane and jane and jim, but these this is an anonymous couple. Uh, so we’re going to start with jane.

Tracy Burke: 5:33
Jane, jane saves five thousand dollars each year. She does it at the beginning of every year and she does that starting at her age 22, and does that for 10 years. So between 22 up to 32, she saves $5,000 a year and then for the rest of her lifetime, she doesn’t save anything after there. Jim, on the other hand, he does also save $5,000 a year, but instead of starting at age 22, he waits to age 32, basically when Jane dropped off, and he saves the whole way up until his full retirement age for social security standards, which is age 67. So, assuming they both get the same rate of return and just say it’s a flat 7% year after year return. Brian, who do you think probably has more money at age 67 at that point?

Brian Graff: 6:27
Yeah, you know, I want to say Jim, of course, because on the surface he saved so much more than Jane. But knowing where this conversation is headed, and also because women typically make better decisions than men, I’m going to go with Jane. How does that sound?

Tracy Burke: 6:41
That’s a great response, brian, and you are 100% right. Jane did win the race in this case and again, she saved from 22 up to 32 and then nothing for those next 35, 36 years. Now, those next 35, 36 years, now Jane ends up with $844,000. And keep in mind she only put in $50,000, 5,000 over 10 years. So she put in 50, that grew to 844 because of compound interest in the earnings or in her investment. Jim, on the other hand, he wasn’t far off, 7 was was his end. So about 50 000 less. But keep in mind he saved 180 000 over those 36 years that he was saving between that period of time. So again, jim invested over three and a half times the amount that jane did. He put 180 versus the 50, but he ended up with a bit less. And again, that’s where time matters.

Brian Graff: 7:41
Yeah, that’s pretty amazing. So it tells you that, yeah, over time, even just a modest sum like what Jane contributed over her 10 years can really turn into a massive fortune. Now, some people might not think of $844,000 as a massive fortune, but I think it’s a lot of money, right? I think it goes without saying and for most people it is substantial. So let’s take it a step further, tracy, and use another example. Let’s call this saver, I don’t know how.

Brian Graff: 8:08
About Brian? All right, it’s a good enough name, right? Let’s say, brian started saving $5,000 a year at age 22. Exactly what Jane did, right? Because I just said, jane’s smart, she’s a woman. But one big difference is Brian decided to increase his contributions by 2% every year, essentially to kind of keep up with inflation, and did this throughout his working years up till his retirement age of 67. So what would Brian have had at age 67, assuming an average rate of return of that, you know, 7%, believe it or not, Tracy? Over $2.1 million, right? That is really significant. So you know, kind of, just looking at the math on that, from age 22 through age 67, brian saved about $371,000, meaning that the earnings compounded to over $1.75 million. So most of all that fortune was because of the compound interest associated with that savings.

Tracy Burke: 9:13
So Brian, I know that’s a hypothetical Brian right, but if you, brian, if you save there man, you would be in pretty good shape at 67.

Brian Graff: 9:22
I would certainly take it Tracy Yep, I would not look back. I would enjoy those frequent trips to the beach and enjoy my retirement for sure If I could just do what Jane did and then keep saving until retirement age.

Tracy Burke: 9:34
Yeah, so that’s the most ideal situation, right? Not start late like Jim did, or not start early like Jane did and then stop, but just to go throughout. And that’s obviously. And those numbers again are staggering in terms of the investment gain and what’s happened. So if we transition just a little bit here to talk about a couple of the other elements so we talked about the importance of saving and how investments can grow, and whether it’s within retirement accounts outside of retirement accounts obviously works the same manner but also want to talk about bank savings too, because compound interest there works as well. We’re in an environment now where interest on bank accounts is higher than it’s been for maybe over the past 20 years, Right, but it’s important to get higher interest and search out making sure you’re getting those best interest rates on your bank accounts, Right, Brian?

Brian Graff: 10:32
Yeah, definitely. And you know we use the example of emergency funds right that rainy day account and you know, for many, many years, high-yield savings accounts or product that might give you closer to a 3.5% return versus a half a percent can really have a substantial effect even on, again, those rainy day funds, as we like to call them.

Tracy Burke: 11:07
Yeah, and a lot of times the brick-and-mortar banks and most of us use a brick-and-mortar bank for at least some of our banking functions right, if you call them up or if you walk in, they’re probably not going to be able to give you that three and a half 4% interest rate. Where a lot of folks are getting those high yield savings that Brian mentioned. Those are generally found on these online based banks that have less expenses and so they’re able to do them, but they’re very reputable. They are FDIC insured. So again something if you’re getting just very little in your bank savings, something considered there that can help with compounding it, even as time goes along. And then something else I think it’s worth mentioning for our viewers, brian back in 2022, congress and they passed what was known as Secure Act 2.0. Now, for the average person, you probably maybe heard it a couple of years ago and, yes, that was 2.0. There was a 1.0, I think was back in 2019.

Tracy Burke: 12:09
Those of us in the financial space, these are some of the more monumental laws that Congress has passed, especially for retirement savings and some tax elements and some other things here for quite a while. 529 college saving account money you know, 529 account money to a Roth over a period of five years if somebody ends up with excess money in a 529. The student got scholarships or some other areas, or just the school wasn’t as expensive as maybe what they they originally thought it was going to be end up with excess money in a 529. And again, the good news is is that law allows you to move excess money in 529 to a Roth IRA. Now, at some point we’ll talk about Roth IRAs, because they were super powerful, uh, but tax-free earnings and great ways to also save for retirement. If you can do that, uh.

Tracy Burke: 13:20
So I’m going to use another example and let’s call this person Fred, all right, so Fred’s a student and his parents just ended up with too much in a 529. Again, you know, for whatever those reasons are, what this law allows, they can do the max contribution, and right now here in 2025, the max Roth contribution for somebody under age 50, and Fred’s a student, so he obviously would be is $7,000. So this law allows a person to move $7,000 for five years from the 529 to a Roth, and the Roth does have to be in Fred’s name. So we do that math 7,000 a year for five years, that’s $35,000, assuming there is that excess in 529s. But moving that money, if you do that from, say, age 22, say after Fred graduates from college, over those first five years that $35,000 of money movement takes that Roth IRA.

Tracy Burke: 14:26
If Fred does not add any more to it, turns that into $690,000 again at age 67. And again, just like the other examples, we’re assuming a 7% annual average return through there. Again, no further contributions. So that’s another powerful way compounding can work, especially if you’re fortunate enough to have that excess into 529. Of course that’s not the goal necessarily, but if you end up there, that’s another way to get money over there and the power of compounding.

Brian Graff: 14:59
Yeah, what a good problem to have. I was just thinking about that, as you were talking Tracy with three kids college age myself, I promise you I was not like Fred’s parents and we did not overfund our 520. So what a good problem to have and another example of how compounding can really benefit you in the future.

Tracy Burke: 15:16
Yeah.

Brian Graff: 15:17
So, yeah, something else. I want to talk about shifting gears a little bit. Tracy is a nice way to kind of a ballpark way to calculate future growth, and it’s something we call the rule of 72. Oh yeah, yep, yeah, this is a good one. So this basically tells you how long it will take your money to double right, so to double in size. So let’s say you have, you know, half a million dollars and you know that when you retire you want to have a million dollars in there.

Brian Graff: 15:43
You can kind of follow the rule of 72. And the way that works is you take that number 72, divide it by your expected return or the interest you make on that money so let’s say 6% and it gives you the number of years it will take for your investment to double. So, for example, you’ll take 72 and let’s say you assume a 6% rate of return. 72 divided by 6 equals 12. So you can expect it to take approximately 12 years for your investment to double. Okay, so that’s it’s a pretty neat quick, back of the napkin way of figuring out how long it would take to double your investments. What do you think about the rule of 72, trace? Is that something you use a little bit when talking to your clients as well.

Tracy Burke: 16:28
Yeah, yeah, quite a bit. And sometimes we don’t outwardly refer to it. But sometimes when we’re talking with clients and say, hey, I want to get to this certain threshold, I want to get my account balance to a million or five million or whatever the number is, how long will it take to get there Sometimes a question. So I often don’t say, well, let me break up my rule 72 calculator and talk through it. But inside your head I’m doing the math like, well, geez, if they’re getting a 5, 6, 7, 8%, whatever the rate of return is, you do the math and you can sometimes come across sounding like a genius. Well, yes, I can figure this out so quickly. But, yeah, so it’s a good way to do it. And keep in mind that that’s assuming no additional contributions be putting in, so you’re not saving there.

Tracy Burke: 17:12
But also then the opposite. Or there’s different ways to sort of do the calculation with that rule of 72. And let’s say, hey, I want my money to double in 12 years. Sort of looking at it from the opposite standpoint, you know I want, so I have this much money, and it might not be a great example but say you’re saving to buy a house. Because if you’re buying a house. 12 years is a long time to sort of save to buy a house. But you’re saving to buy something in the future or you want to get to a certain number and you know you say, hey, 12 years is that mark? Well, it’s just the opposite, right?

Tracy Burke: 17:48
You take 72 divided by 12 and the math you did a few moments ago, brian 6% is that return? So you can figure out how long. You can also figure out what is the rate of return on my investment for doubling as well, for doubling as well. And then maybe one last example what return do I need to double my existing money and again, no further additions over a period of time, and maybe we say over 10 years. What return do I need to get to do that? 72 divided by 10 years would be 7.2%. So you know just a couple of different ways to look at. It can go both ways. But a great way to sort of figure out how does that compounding work without any new money coming in? What can you expect moving forward?

Brian Graff: 18:37
For sure. It’s such an interesting concept. In fact I was prepping for the podcast last night at home and talking to my kids about it and the two that are more into business and again college age 18 and 20, talked about the rule of 72 with them and they kind of looked at me like yeah, are you sure it’s that easy, dad, you know to kind of just do that little bit of math. So I saw my son with his calculator at one point. I’m not sure if he was trying to prove the theory or what he did, but he looked satisfied in the end. So yeah, it’s pretty interesting stuff, that rule of 72. Absolutely Well.

Brian Graff: 19:04
Okay, tracy, you know we’ve talked a lot today about the beauty and the power of compounding, but let’s wrap up and let’s, as always, talk about some action items here a little bit, because, remember, these podcasts only work if we’re giving people steps to take to get where they want to be in their retirement savings journey. So the most important thing I know we’ve said it a few times today everybody is to save right. You know, again, it’s never too early or too late to start saving for retirement, but something I hear myself say on repeat every day talking to retirement plan participants is start now, because even saving just a little bit, as we talked about earlier, can really go a long way and have this incredible impact on your retirement savings because of compound earnings. So get started and, like Brian did in our example, continue to increase your savings a little bit every year. Try not to get too stagnant, because that compounding, while it works wonders, works even better when you continue to save a little bit more every year.

Tracy Burke: 20:04
What else?

Tracy Burke: 20:05
Tracy better when you continue to save a little bit more every year. What else, tracy? Yeah I would say, if you are further along in life and have saved, and whether you’ve adult children, grandchildren, helping to get them started on future savings. We talked about that Roth IRA example. So, grandparents or parents, you know, if we think back to early adulthood, that’s time where cash flow isn’t very good and it’s tough to save at that point. Right, it’s tough to save for retirement, it’s tough to save for a potential down payment for home, even car and all those other type of things.

Tracy Burke: 20:41
So if you’re further along and again you’re able to help, you know whether it’s Roth IRAs for you know helping to further retirement and keep in mind that the grandchild or child does need to have earned income to put money into a Roth for them. But then then then 529s you know from from that standpoint. So, again, get helping them, get started. You know Roth IRAs and 529s, those two because of the tax-free nature they may. If what we’re talking about right now is the eighth one to the world compound interest, those two might be the ninth one to the world.

Brian Graff: 21:16
Yeah, hey, that sounds like a great future podcast topic Tracy Keep that one in mind. I’m going to jot that down right now.

Tracy Burke: 21:22
There we go. And then the other thing is, you know, action item just practice patience and discipline when investing. This doesn’t happen overnight, right? Compound interest takes time. Use that example of Warren Buffett earlier. Just allow it to grow. You know, if we think and I’ve heard this many years ago and it might even be from Warren Buffett because he has so many great quotes or great thoughts out there but you know it’s it’s like going out and planting a tree. If I go out and plant a tree, you know, in my yard, and then in a year from now I’m disappointed because it didn’t grow more and I dig it up and then I’m like, well, geez, I’m gonna go and plant in brian’s yard, right, because maybe his soil is more fertile and maybe we’ll go there. We just just got to give it time to grow, right. So patience and discipline is super important when investing and allowing that growth.

Brian Graff: 22:12
Yeah, I love that shady tree analogy, tracy, yeah, so thanks everybody for listening to us today. We hope that you enjoyed this topic as much as we did, and I just want to remind everybody please reach out to us with any questions that you may have, whether it’s about this specific podcast topic or just investing and saving in general. We are here to help. So please email us at podcast at conradsegalcom, and, you know, please be sure to share this episode, or any of our podcast episodes with family and friends. We’d love people to get the word out for us a little bit. We hope we’re putting out some good, important information and if you like what you hear, please give us a five-star review and subscribe to the podcast as well. Well, until next time, tracy. A pleasure as always, my friend, and look forward to the recording episode number four pretty soon. Have a great day.

Intro/Close: 23:06
Thank you for tuning into today’s show. The Real Talk Retirement Show is created and produced by Conrad Siegel, an advisory firm that specializes in helping people prepare for retirement and beyond. If you want to learn more about our work or meet the team, you can visit conradsegelcom. Information on this show is for educational purposes only and should not be considered personalized investment tax or legal advice. Before making decisions, you should consult with the appropriate professionals for advice that is specific to your situation.