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Compound interest, the eighth wonder of the world

Albert Einstein once wrote, "Compound interest is the eighth wonder of the world. He who understands it, earns it...he who doesn't...pays it." So how does one get to be on the winning side of this equation? One way is through our retirement accounts.

My first recommendation to students and clients is to maximize the matching funds that may be offered by your employer. Let's say, for example, your employer does a 5% matching fund. If you're making $75,000 a year, 5% would be $3,750 dollars. So, every year when you put in your $3,750, the company puts in the same amount. What you've done is make 100% on your money before the money earns anything! If you were age 30 retiring at 65 you would have (assuming 6%) over $400,000 for your retirement. If you took advantage of the matching funds, you'd have well over $800,000.

Another way to see compound interest work for you is through an IRA or Roth IRA account. The most you can put in an IRA is $6,000, depending upon your family income. Once you hit age 50 that limit changes to $7,000. Using our above example, if you were able to maximize the IRA contribution and you were say age 40 retiring at 65 you would have (again assuming 6%) over $340,000 or more if you were able to take advantage of the increase at age 50. With the IRA you get the tax write off every year, but when you start withdrawing the money the entire amount is taxable BUT you've taken advantage of that compound interest the professor was talking about. If you don't need the write off for your taxes then choose the Roth IRA, the dollar amount in retirement would be the same but there would be no tax on any of the dollars in the account.

In many accounts you can do as little as $50 to $100 a month. Whatever you can contribute takes advantage of the principle of compound interest, let it work for you. It's an incredible concept!

Marty Pay has been a Farmers Agent for over 40 years, he is a Financial Planner and teaches Finance at a local university. His office is located at 212 West F St., Tehachapi, (661) 822-3737.