Parallels Between Memory and Compounding Returns

Brent Schafer

Why does time seem to speed up as we age?

There are a few different ideas on why this is the case, but one can simply use math to explain. As we age, we begin to experience more time and life events. Our memories slowly begin to fill up and the time experienced begins to compound itself. Depending on who you ask (or your own memory), the average human mind begins to exhibit adult-like capabilities of memory around ages 5-7.

For this example, we will start from birth. In our first year of life, everything is a new experience, and those experiences fill up 100% of our accessible memory. In the second year of life, we build upon the first year of memories, leaving only 50% of the accessible memory with which to work. Essentially, this goes on and on, year by year throughout one’s life. Below is a chart of the relative contributions to memory from an individual’s perspective from their 20s to their 80s.

At age 20, a year’s worth of time should equate to about 5% of the overall experiences in a person’s life. At age 89, that percentage drops to 1.12%.

This article does a great job of explaining and describing different ways that you can ‘slow down’ time: http://blog.idonethis.com/science-of-slowing-down-time/

Why do I bring all of this up?

A similar comparison can be drawn to investments and retirement contributions. Contributions earlier in life have more time to grow and compound in value. If the goal is to invest for retirement, a dollar invested in your 20s and 30s is worth much more than a dollar invested in your 40s and 50s. Invest early if you are able to do so.

The graph below highlights how time in the market can be helpful for the growth of your investments. In this example, I used a 7% average return.

Compounding Returns from ages 20 to 60

Do you notice how the arc of both graphs look similar? It might just be a fun coincidence that these graphs look alike, but the reason for the shape of the bar graph is how long the investment is allowed to grow. Dollars invested later in life do not have as much time to work for you.

How do compounding returns fit in?

Let’s compare investing $1 at age 20 and $1 at age 60 to make a stark comparison. At age 60, an investment only has 5 years to grow until age 65, which I have used as a hypothetical end date (retirement) for this illustration. At age 20, the initial investment has 45 years to grow at an average of 7%. Essentially, the dollar that was invested at age 20 has 40 more years to compound than the dollar that was invested at age 60.

Compounding Returns from ages 20 and 60

It is not a secret that compounding returns can help tremendously over the long term. Vanguard founder and index fund inventor Jack Bogle had this to say about investing early in life, “Enjoy the magic of compounding returns. Even modest investments made in one’s early 20s are likely to grow to staggering amounts over the course of an investment lifetime.”

If the memory analogy leaves you feeling hopeless and thinking that life has passed you by, there are a few hacks that can help. Humans do their best to remember novel experiences, which can be hard to achieve with regularity. Personally, I love to keep a routine; though whenever I try something new, I tend to remember it more vividly than things that I have done over and over again.

Overall, this is not meant to discourage those who have gotten a late start to saving. Retirement looks different for everyone. While it might be true that starting to invest early might be the best method for allowing investments to grow, it is not always feasible. Everyone’s financial standing is different. Alongside investing, there are other financial goals and objectives an individual may seek – saving for a house, college education, or another shorter-term goal – can shift focus away from saving money for retirement. Saving money can feel overwhelming at times, but if you have defined goals, it can be easier to chart a path toward meeting your objectives. The best time to start is now. A good financial advisor will help you prioritize your goals and come up with a realistic savings plan to set you up for success.

As always, if you should have any further questions, please contact an advisor at HFG Trust.

 

Brent Schafer, CFP®
Financial Planner