One of my favorite quotes from Warren Buffett, arguably the world’s greatest investor, is “My wealth has come from a combination of living in America, lucky genes, and compounding interest.”
What is compound interest? Quite simply, with regards to long-term investing, it is your best friend! As for the technical definition, compound interest or compounding interest is interest calculated on the initial principal and also on the accumulated interest of previous periods of a deposit or loan. For those who don’t understand compounding interest, the concept is easier to understand with an example:
Under current IRS law, anyone with earned income can contribute up to $5,500 per year to a Roth IRA (single earners making up to $120,000 per year can make full contributions; single earners making between $120,000 and $135,000 per year can make reduced contributions; and, earners making more than $135,000 are ineligible for Roth IRA contributions). So, if your child/grandchild has earned income (you may consider hiring your child around the house or, if you have your own business or professional practice, they can work for you in your office), they are eligible to contribute to a Roth IRA and start benefiting from the powers of compounding.
Suppose that the child contributes $4,000 per year to a Roth IRA from the ages of 16 to 21 and then never makes another contribution. If the account earns 10% per year, at the age of 65, the child will have a tax-fee account valued at $2,045,042. That is the power of compounding!
It is really that simple. Get your kids earning and investing at an early age; educate them on how Roth IRAs work; and, the power of compounding interest will take care of the rest!
If you have any questions or would like to discuss this further, please reach out to our Fayetteville or Plano office.
-Louis Shaff, CFO
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