The Magic of Compounding

It looks like 2008 is shaping up as the year Americans are getting serious about saving.

In a survey by the American Institute of Certified Public Accountants, 25% of U.S. adults said they are spending smarter this year, or not spending as much, to save money -- up from just 2% in 2007. A survey by HSBC Direct found that 81% of those who responded want to increase the amount they save in 2008.

What really fires people up, according to a study by Wachovia and the Consumer Federation of America, is a graphic illustration of the real secret to successful saving: Thanks to the magic of compound interest, even small amounts of money can grow into big piles of cash over time.

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For an eye-opening example, consider two young people, Kevin and Kelsey. At age 20, Kevin begins contributing $3,000 per year to an IRA. He continues for ten years and then stops, letting his money sit in the account.

Meanwhile, Kelsey delays saving until age 30, when she starts contributing $3,000 every year to an IRA. Who will have more money at retirement?

Abracadabra, the answer is Kevin. Even though he stopped contributing after ten years, his retirement fund will grow to $1.5 million, assuming a 10% annual return (the historical stock-market average).

In contrast, Kelsey, who saved $3,000 a year until retirement but started ten years later, will amass a little more than $900 000. To run your own numbers, see our How much will my savings be worth? (opens in new tab) calculator. (For a calculator geared toward younger children, go to the Saving Rocks page at www.orangekids.com (opens in new tab).)

Of course, final totals will differ depending on when you start, how much you contribute and how much you earn. But all other things being equal, the results are always the same: The earliest bird winds up with the fattest worm.

It's easy to capitalize on the magic of compounding (opens in new tab). You can set up an automatic transfer to a bank or investment account or to your company's retirement plan (see Ten Sneaky Saving Strategies (opens in new tab)).

To jump-start saving among its young customers, Wachovia has introduced its Way2Save account. Set up a Wachovia checking account and you can automatically transfer up to $100 each month to a savings account that pays 5% for the first year, and 2% in the second and third years.

Plus, each time you pay a bill online or use your Wachovia check card, $1 will be transferred from your checking to your savings account. And there's an annual savings bonus based on your account balance.

Wachovia estimates the average customer should accumulate $2,000 over three years -- a good start toward building an emergency fund or seeding that IRA.

Coming: Saving tips for younger children.