Understanding the Impact of Compounding Increases Savings Rates
Knowing how big of an impact compounded returns will have on retirement savings can prompt investors to save more money. In a study scheduled to be published in the November issue of the Journal of Marketing Research, researchers came to this conclusion after looking into how understanding the exponential growth created by compounding affects savings rates.
The study relied primarily on college students, though employees of a Fortune 100 company were used for one of the experiments. Authors Craig McKenzie of the University of California, San Diego, and Michael Liersch of New York University found that many participants misunderstood compounding and the costs of delaying saving for retirement. They also found that when shown the positive effect of long-term compounding, participants were motivated to increase their savings.
Many college students, and likely many college graduates, incorrectly assumed that savings grow linearly, rather than exponentially. The result was that the median estimate of what an account balance’s size would be was less than 10% of what it would be after a period of 40 years with a given projected rate of return.
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