In order to make informed decisions about 401(k) plans and other retirement savings strategies, you need to understand some basic financial concepts. One of these is the time value of money, the idea that money should increase over time. One good way to achieve this is using compound interest, where interest earned on the principal in an account is put back into the account, where it also earns interest.
Dollar cost averaging is a strategy for reducing risk when you invest over time. You will also need to understand the effects of inflation, and the differences among pre-tax, after-tax, tax-deferred and tax-free.*
The concept of time value of money is that, over time, you should earn interest on your money. Money invested in interest bearing vehicles begins to grow as soon as it's invested. The earlier you start investing in your 401(k) plan, the more time your money has to grow.
Look at the following chart to see the value in starting early:
|Starting Age||Ending Age||Total Contributed||Years Contributed||Estimated Value at Age 65|
- Employee #1 and #2 each contribute $1,000 per year for 10 years.
- Rate of return - 8%.
- Money is growing tax deferred in a 401(k) plan.
- All interest and gains are reinvested.
Doesn't look right, does it? Depositing the same amount of money ten years earlier will give you twice as much money at age 65. This is the result of something called compound interest. The interest and gain you get on your money over the years keeps getting reinvested and earns more interest. Your principal earns interest and your interest earns interest. Over time it makes your money grow faster and faster. And the more years you have to make this compound interest cycle work, the more money you'll have when you retire. Use the time you have to your advantage by saving now and saving more.
*Dollar-cost averaging cannot guarantee a profit or protect against a loss, and you should consider your financial ability to continue purchases through periods of low price levels.
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Infinex and First Commonwealth Bank are not affiliated. Products and services made available through Infinex are not insured by the FDIC or any other agency of the United States and are not deposits or obligations of nor guaranteed or insured by any bank or bank affiliate. These products are subject to investment risk, including the possible loss of value.
*We do not provide tax advice. Consult your tax advisor.
*Diversification is a method of controlling risk. It does not assure a profit or the avoidance of loss.
**Dollar-cost averaging is a method of controlling risk. It does not assure a profit or the avoidance of loss. Investors should consider their ability to continue a dollar-cost averaging program in periods of declining markets.