This hypothetical example is for illustrative purposes only and is not intended to reflect the return of any actual investment. Investments do not typically grow at an even rate of return and may experience negative growth.

Investor B figured he could catch up but he never did. And when you remove the contributions, you can see that the net earnings difference is substantial.

Many people faced with Investor B's situation have trouble catching up because, outside of a significant salary increase and subsequent decision to save even more, it can be difficult to change spending habits that have developed over time to support a desired lifestyle. In this example, Investor B would have to invest $428.15 per month just to reach same $565,391 portfolio value at age 65. Of course, a bigger chunk of the heavy lifting would be done by his own contributions, rather than compounded growth.

Factors affecting the future value of money

Amount invested Rate of return/what it's invested in Length of time the money is invested Number of compounding periods (monthly, quarterly, annually)

Keep in mind that you can contribute far more than the $200 per month used in this example to fund retirement plans. Investors who have earned income and are under age 50 in 2008 can contribute up to $5,000 to an Individual Retirement Account (IRA). Investors 50 and over can contribute up to $6,000 assuming they have that much earned income for the year. Employer-sponsored retirement plans typically have contribution limits nearly triple that. Check with your human resources representative or review your summary plan description for details of your company's retirement plan.

The more you contribute, the more compounding can work for you to grow your savings.

How compounding works
Your investments can achieve compound growth in several ways:

In an investment such as a money market savings account or certificate of deposit, you can receive interest on interest If you own stock that pays cash dividends, you can reinvest the dividends, thereby purchasing more shares of the stock, increasing your next dividend payment. With some bonds, interest paymnets get added to the original amount (or principal), which makes each successive payment larger. In the situation of a tax-deferred retirement plan, your investments' growth is also compounded when you compare it to what it would have been if taxes were taken out every year. Because taxes are deferred, you don't have to sell any investments to pay taxes on the year's gains, if your portfolio increases. And all of your interest income can be reinvested. The result is that interest income keeps compounding, dividend reinvestments have the opportunity to continue growing, and your investment portfolio continues to put your money to work, subject to the volatility of the investment markets. Of course, you can't avoid taxation of non-Roth retirement accounts forever. When you do begin to withdraw your money from tax-deferred retirement accounts, you will owe ordinary income taxes on the entire amount distributed. Your tax bracket will determine the tax cost.

Rather than have a fl at 9% of $2,000 over an annual period, earning $180, the rate of return is compounded monthly so that earnings can grow on earnings each month. In this example, an extra $7.60 was earned. It may not add up to an overwhelming amount in a short time period with a limited amount invested but the longer your time horizon and the more consistently you invest, the more staggering the impact of compounding becomes.