401k compound interest vs other compound interest
A 401K (pre-tax or Roth) account or an IRA (Deductible or Roth) account is a retirement account. Which means you delay paying taxes now on your deposits, or you avoid paying taxes on your earnings later.  But a retirement account doesn't  perform any different than any other account year-to-year. Being a retirement account doesn't  dictate a type of investment. You can invest in a certificate of deposit that is guaranteed to make x% this year; or you can invest in stocks, bonds, mutual funds that infest in stocks or bonds. Those stocks and bonds can be growth focused, or income focused; they can be from large companies or small companies; US companies or international companies. Or whatever mix you want. The graph in your question shows that if you invest early in your adulthood, and keep investing, and you make the average return you should make more money than starting later. But a couple of notes:  So to your exact questions: An S&P 500 investment should perform exactly the same this year if it is in a 401K, IRA, or taxable account With a few exceptions:  Yes any investment can lose money. The last 6 months have been volatile and the last month and a half especially so. A retirement account isn't any different. An investment in mutual fund X in a retirement account is just as depressed a one in the same fund but from a taxable account. Growth in a 401k dodges taxes, which means more of the gains get reinvested. Effectively, it's a boosted return rate. Like any investment, a 401k can lose value. During the period before retirement, lower stock and bond prices actually help you buy more shares than you could if prices were high, so the real question is what the funds are doing at the time you start pulling money back out. That concern is why investors generally, not just 401k investors, should change their investment mix over time, to balance oossible risk against time to recover and possible reward.  And if your employer matches 401k contributions to any degree, that too improves your effective gains and buffers you against some of ghe risk. Hence the general advice that if you don't fund your 401k at least enough to max out the company match, you're leaving free money on the table. 1a. It isn't. Compound interest is compound interest. It works no different within a 401(k). 1b. Yes. 401(k)'s are made up of the same underlying assets that you could invest in with a regular brokerage account.
The really simple answer is that compound interest is compound not linear.  Money invested for longer earns more interest, and the sooner you start investing, the longer it has to earn interest.  These ideas come out of pension investment where 65 is the usual retirement age and what you invest in the 1st ten years of your pension (or any other compound interest fund) accounts for over 50% of what you will get out. 25 to 65 is forty years and $100 invested at 7% for 40 years is $1400.  $100 invested every year for 40 years the pot would be worth just under $20,000. At 30 years, it would be worth under $10,000, and at 20 years it would be worth only $4099.  If you double your investment amount every 10 years you would have invested $15700, and the pot would be worth $45,457. Do exactly the same but starting at 35 instead of 25 and your pot would only be worth $14,200. The main reasons are that investment are deducted from your gross income and earnings are not taxed until withdrawal. This applies to both traditional IRAs and 401Ks. Roth accounts have different rules but valuable benefits. My effective income tax rate is around 35%. This means that for every $1000 I earn in wage I only get to keep $650. Since my 401K contributions are deferred reductions from my income I can invest 35% more money into my 401K than I would be able to invest in a non-tax-advantaged account. Where I can invest $1000 into my 401K I would only be able to invest $650 into a non-advantaged account with the same wages. If I put $650 into an account yielding 10% then my one-year return on my income is $65 The 10% return on my $1000 is $100. Compared to what I would have been able to take home in the first place this makes my ROI $100/$650 = 15.3% Interest earned in non-advantaged accounts incurs taxes every year. Interest earned in advantaged accounts does not incur taxes until withdrawn. Compounding 10% annually for 20 years is significantly more than 6.5% compounded annually for 20 years. Imagine 10% on a 1000 investment with no additional cash flows over 20 year. The result is $6727, or 672%. Imagine your income tax rate does not reduce below 35%, your after-tax return is 4372, or %437 return. Now imagine you pay taxes every year on 10% take, so your take annually is only 6.5%... Now over 20 years you have $3523 (but you've already paid all taxes on this) and your return is %352 You have earned 24% more money because taxes were deferred until withdrawal! EDIT: Some tabular info for the commenters Your take home from the investment is $3752 because you have diligently paid your taxes every year on the earnings. Now, with the tax deferred until withdrawal! You then owe 35% tax on the withdrawal so you keep 7400 * .65 = $4810 $4810 versus $3750 means you have made an additional $1060, or 28%, from the compounding against tax-advantaged earnings. But Matthew! you say... Annual proceeds from your investments are not taxed at your income tax rate. This is true for now but the political winds are pushing this direction. However, even if you use a reduced rate in the first situation (let's say 30% instead of 35%, if you're a California resident) then the effect is $4140 rather than $3750. Less of a gain, but still a gain. In fact your capital-gains rate would have to be as low as 22% to even this difference out (versus a 35% income tax rate).... And remember that this assumes you're in the same bracket at retirement (which more people are not) You may also note that I used $1000 as the principle in both calculations. This was intentional to show the effects of compounding the taxable earnings alone. If you replace the taxable principle with $650 instead of $1000 then the effect is even more pronounced and only balanced out if your capital gains rate is actually zero! "APY stands for Annual Percentage Yield, a calculation done by the financial institution to make simple comparisons of account value after 1 year between competing accounts. The APY includes the effects of compound interest regardless of the rate of interest, so the simple answer is: no, your return is only your principle multiplied by the APY after a year. Credit Unions are more member participatory than a bank, so the name ""share"" implies that you own a share of the credit union and it's future. It's possible that the CU could elect to pay a dividend on top of your interest rate. Since you have the option to credit the dividend to the share certificate account or another place, it seems that interest would be paid on the dividends left in the SC on the compounding schedule at the contracted rate.  You would have to look at the terms of the account to verify precisely when the dividend is payed, whether it's a value above and beyond the interest, and how it is compounded into our account." "You seem to think that you are mostly paying interest in the first year because of the length of the loan period. This is skipping a step.  You are mostly paying interest in the first year because your principle (the amount you owe) is highest in the first year.  You do pay down some principle in that first year; this reduces the principle in the second year, which in turn reduces the interest owed. Your payments stay the same; so the amount you pay to principle goes up in that second year. This continues year after year, and eventually you owe almost no interest, but are making the same payments, so almost all of your payment goes to principle. It is a bit like ""compounded interest"", but it is ""compounded principle reduction""; reducing your principle increases the rate you reduce it. As you didn't reduce your principle until the 16th year, this has zero impact on the interest you owed in the first 15 years. Now, for actual explicit numbers.  You owe 100,000$ at 3% interest.  You are paying your mortgage annually (keeps it simpler) and pay 5000$ per year. The first year you put 3000$ against interest and 2000$ against principle. By year 30, you put 145$ against interest and 4855$ against principle.  because your principle was tiny, your interest was tiny." "Basically, a 401(k) can have what is called a ""loan"", but is more properly a ""structured withdrawal and repayment agreement"". This allows you to access your nest egg to pay for unforeseen expenses, without having to actually cash it out and pay the 10% penalty plus taxes. You can get up to half of your current savings, with an absolute cap of $50k, minus the balance of any other loan outstanding. While there is a balance outstanding, you must make regular scheduled payments. The agreement does include an interest rate, but basically that interest money goes into your account. The downside of a 401(k) loan is the inflexibility; you must pay the scheduled amount, and you also have to keep the job for which you're paying into the 401(k); if you quit or are fired, the balance of the loan must usually be paid in 60 days, or else the financial institution will consider the unpaid balance a ""withdrawal"" and notify the IRS to that effect. Now, with a Roth account, it works a little differently. Basically, contributions to any Roth account (IRA or 401(k)) are post-tax. But, that means the money's now yours; there is no penalty or additional taxes levied on any amount you cash out. So, a loan basically just provides structure; you withdraw, then pay back under structured terms. But, if you need a little cash for a good reason, it's usually better just to cash out some of the principal of a Roth account and then be disciplined enough to pay back into it." In my mind its not the same.   If growth is stock value then this is incorrect because of compound interest in stock price. $100 stock price after one year would be $105 and a dividend would be $2 Next year the stock would be  $110.20 (Compound Interest) and would the Dividend really go up in lock step with the stock price? Well probably not, but if it did then maybe you could call it the same. Even if the dollars are the same the growth rate is more variable than the dividends so its valuable to segregate the two. I am open to criticism, my answer is based on my personal experience and would love to hear contrary positions on this. "Thanks!  Do you know how to calculate the coefficients from this part?:  ""The difference between the one-year rate and the spread coefficients represents the response to a change in the one-year rate. As a result, the coefficient on the one-year rate and the difference in the coefficients on the one-year rate and spread should be positive if community banks, on average, are asset sensitive and negative if they are liability sensitive. The coefficient on the spread should be positive because an increase in long-term rates should increase net interest income for both asset-sensitive and liability-sensitive banks.""  The one-year treasury yield is 1.38% and the ten-year rate is 2.30%.  I would greatly appreciate it if you have the time!" "There is a very simple calculation that will answer the question: Is the expected ROI of the 401K including the match greater than the interest rate of your credit card? Some assumptions that don't affect the calculation, but do help illustrate the points. You have 30 years until you can pull out the 401K. Your credit card interest rate is 20% compounded annually.  The minimum payoffs are being disregarded, because that would legally just force a certain percentage to credit card. You only have $1000.  You can either pay off your credit card or invest, but not both.  For most people, this isn't the case.  Ideally, you would simply forego $1000 worth of spending, AND DO BOTH  Worked Example: Pay $1000 in Credit Card Debt, at 20% interest.   After 1 year, if you pay off that debt, you no longer owe $1200.  ROI = 20% (Duh!) After 30 years, you no longer owe (and this is pretty amazing) $237,376.31.  ROI = 23,638% In all cases, the ROI is GUARANTEED. Invest $1000 in matching 401k, with expected ROI of 5%. 2a. For illustration purposes, let's assume no match After 1 year, you have $1050 ($1000 principal, $0 match, 5% interest) - but you can't take it out. ROI = 5% After 30 years, you have $4321.94, ROI of 332% - assuming away all risk. 2b. Then, we'll assume a 50% match. After 1 year, you have $1575 ($1000 principle, $500 match, 5% interest) - but you can't take it out. ROI = 57% - but you are  stuck for a bit After 30 years, you have $6482.91, ROI of 548% - assuming away all risk. 2c. Finally, a full match After 1 year, you have $2100 ($1000 principle, $1000 match, 5% interest) - but you can't take it out. ROI = 110% - but again, you are stuck. After 30 years, you have $8643.89, ROI of 764% - assuming away all risk. Here's the summary - The interest rate is really all that matters.  Paying off a credit card is a guaranteed investment.   The only reason not to pay off a 20% credit card interest rate is if, after taxes, time, etc..., you could earn more than 20% somewhere else.   Note that at 1 year, the matching funds of a 401k, in all cases where the match exceeded 20%, beat the credit card. If you could take that money before you could have paid off the credit card, it would have been a good deal. The problem with the 401k is that you can't realize that gain until you retire. Credit Card debt, on the other hand, keeps growing until you pay it off. As such, paying off your credit card debt - assuming its interest rate is greater than the stock market (which trust me, it almost always is) - is the better deal. Indeed, with the exception of tax advantaged mortgages, there is almost no debt that has an interest rate than is ""better"" than the market."