- Saving early and consistently is the most powerful financial advice for young people offered by Katie Nixon, the chief investment officer at Northern Trust Wealth Management.
- Starting early helps savers take advantage of compound interest, which basically means letting both the balance and older interest payments earn even more interest over time.
- It's costly to start late and then try to play catch up.
It's just two words: compound interest.
Understanding the power of this concept, and more crucially, putting it to work by saving, is crucial to building wealth over time, according to Katie Nixon, the chief investment officer at Northern Trust Wealth Management, which has $287 billion in assets under management. The firm's clients include 20% of Forbes' 400 wealthiest Americans, private businesses, and individuals.
Savings accounts are important for the inevitable rainy day and because they earn free money in the form of interest. And that's where compound interest comes in. Basically, leaving a savings account to grow over time ensures that interest is earned not just on the balance, but on old interest that's already been earned.
Recognizing how powerful this concept is in the long run is the best advise for a young person figuring out their finances, according to Nixon.
"It's the most powerful answer I can give, and that is, save as much as you can as early as you can," Nixon told Business Insider when asked her advice to someone starting their career.
"Start saving and enjoy the benefits of the eighth wonder of the world, which is compound interest."
The chart below shows the power of compound interest through three hypothetical people who started saving at various stages of their careers. It assumes that each person except the third (more on that in a second) put aside $100 monthly in an account with a 3% interest rate.
Clearly, the person who started earliest, at age 25, had the most cash by the time they were 65. It also shows that it is costly - now and at retirement - to start late and play catch up; the person who started at 40 and saved twice as much fell behind the person who started earliest.
What about the stock market?
Investing in stocks is riskier than piling on cash - but it's a risk worth taking, Nixon said.
"We work with a lot of multigenerational families, and when we're talking to some of our younger clients, who are 19 and 20 years old, we give them this advice: Don't be afraid to invest," she said.
"Markets don't go up every year, but, over time, they do go up. Form a habit and keep investing over time, and recognize that people who are young right now potentially could live well past 100 years old."
Warren Buffett, the most famous investor of this era, recommends keeping things simple, especially for people who aren't sure where to start.
"My regular recommendation has been a low-cost S&P 500 index fund," Buffett, the chairman of Berkshire Hathaway, said in his 2016 letter to shareholders. Such an exchange-traded fund (ETF) would move in lockstep with the S&P 500, and spread the risk of betting on a handful of companies.