# How to Make Compound Interest Even More Effective: Part 2

In my last post I talked about how to increase the effectiveness of compound interest through contributing every single year to a savings account and increasing the amount you contribute. In this post I want to bring up another powerful way to make compound interest more effective: contribute as much as you can early on.

Let’s look at an example to see the importance of contributing as much money as possible early on. Person A contributes \$30,000 to their savings account in year 1 and year 2. Then, for the next 13 years they contribute \$5,000 every year. Person B, on the other hand, simply contributes \$5,000 every year for 15 years. Let’s assume each account grows at a 6% interest rate. Let’s see how our two people compare at the end of 15 years:

 Year Person A Contribution Total \$ Person B Contribution Total \$ 1 30,000 31,800 5,000 5,300 2 30,000 65,508 5,000 10,918 3 5,000 74,738 5,000 16,873 4 5,000 84,523 5,000 23,185 5 5,000 94,894 5,000 29,877 6 5,000 105,888 5,000 36,969 7 5,000 117,541 5,000 44,487 8 5,000 129,894 5,000 52,457 9 5,000 142,987 5,000 60,904 10 5,000 156,866 5,000 69,858 11 5,000 171,578 5,000 79,350 12 5,000 187,173 5,000 89,411 13 5,000 203,703 5,000 100,075 14 5,000 221,226 5,000 111,380 15 5,000 239,799 5,000 123,363

At the end of the 15 years, person A has over \$116,000 more than person B in their savings account! So even though person A and B contributed the same amount during years 3 through 15, the simple fact that person A contributed far more in the first 2 years made all the difference. This example illustrates the importance of saving as much money as possible while you’re young and letting that money compound over time.

### But What About Market Crashes??

But there’s one caveat to consider. What if you happen to invest a ton of money when you’re young like Person A, but then the market crashes? Lucky for you I ran the numbers on historical data going all the way back to 1960.Consider the following two scenarios:

Scenario 1: You contribute \$20,000 to a savings account in year 1, despite whether you think the market is overvalued or not.

Scenario 2: You fear the market may be overvalued so you hold your \$20,000 in cash in year 1 but then in year 2 you contribute \$20,000.

The following table shows the 10 year return you would have had on your initial contribution of \$20,000 in both scenarios.

 Starting Year S&P 500 Return Scenario 1 10 Year return Scenario 2 10 Year return Scenario with higher return 2006 15.7% 40,410 34,915 1 2005 4.8% 41,802 39,892 1 2004 10.8% 40,704 36,730 1 2003 28.7% 39,564 30,736 1 2002 -22.3% 26,539 34,142 2 2001 -12.0% 22,886 26,000 2 2000 -9.1% 18,108 19,923 2 1999 21.1% 17,253 14,246 1 1998 28.7% 35,378 27,482 1 1997 33.7% 44,841 33,546 1 1996 23.1% 47,677 38,743 1 1995 38.0% 62,796 45,498 1 1994 1.2% 57,339 56,665 1 1993 10.2% 49,076 44,546 1 1992 7.6% 67,935 63,137 1 1991 31.0% 101,069 77,181 1 1990 -3.4% 107,396 111,199 2 1989 32.0% 117,053 88,677 1 1988 16.6% 106,060 90,929 1 1987 5.7% 83,859 79,344 1 1986 19.1% 81,133 68,145 1 1985 32.2% 77,736 58,784 1 1984 6.0% 81,400 76,821 1 1983 23.1% 90,976 73,886 1 1982 21.2% 102,491 84,550 1 1981 -5.3% 74,096 78,267 2 1980 32.8% 101,853 76,720 1 1979 18.7% 91,583 77,161 1 1978 6.4% 83,550 78,518 1 1977 -7.8% 72,902 79,052 2 1976 24.2% 76,049 61,231 1 1975 38.5% 79,626 57,509 1 1974 -27.0% 54,895 75,148 2 1973 -15.0% 37,882 44,583 2 1972 19.2% 37,235 31,251 1 1971 14.5% 45,051 39,332 1 1970 3.6% 35,156 33,934 1 1969 -8.6% 27,063 29,620 2 1968 11.0% 28,239 25,433 1 1967 24.5% 38,108 30,621 1 1966 -10.4% 27,504 30,682 2 1965 12.5% 22,337 19,864 1 1964 16.6% 35,651 30,578 1 1963 23.0% 51,624 41,957 1 1962 -9.2% 39,341 43,327 2 1961 28.5% 44,139 34,347 1 1960 -0.7% 42,290 42,605 2

In 35 of the 47 ten-year return time periods, you would have made more money by choosing scenario 1. That means about 75% of the time you would have made more money by just investing in the market as soon as possible and not trying to wait an extra year for the market to dip.

Why does this strategy make sense? It’s because most years the market has positive returns. So if you wait an additional year to invest, you’re most likely going to miss out on making some money. Obviously if you knew the market was about to crash it would be beneficial to wait an extra year to invest, but it’s nearly impossible to know when the market will actually crash. For example, from 1982 through 1999, the market only lost money in one year. So you would have been waiting a very long time for the market to crash to actually start investing, and you would have missed out on all those returns.

### Key Takeaways

• Contribute as much as possible early on – compound interest is extra magical when you give it plenty of years to work
• Don’t wait for the market to crash to invest your money – you might be waiting longer than you think