Compound Interest—The Best Thing Since Sliced Bread

We all know that saving is a necessary component to building wealth.  Save $100 this month, $50 the next, and in two months you’ll have accumulated $150.  Big whoop-ti-do!  Doesn’t seem like a whole lot right?  Let’s put things into perspective.  The reason why savings is so huge is due to a little known fact called “Compound Interest”.

Albert Einsten was once quoted saying “The most powerful force in the universe is compound interest”. Well, the jury is still out whether or not he said it, but for the sake of this post, he did.

What exactly is Compound Interest?

It’s generating interest income off the principal (funds) you already have. It could be monthly, semi-annually, or annually.  In most cases, this is a monthly event.

How do I start using Compound Interest to my advantage?

First, pay off bad debt like debt from high-interest credit cards. Bad debt must be paid off first because the interest earned on your compounding principal cancels out against the interest that is charged against you through bad debt.  Once your bad debt is paid off, let’s begin.

For example, if you currently have $0 in savings and the capability to sock away $100 a month into a mixture of high-interest investment vehicles (savings, stock market, ETFs, etc) that have an ANNUAL RETURN of 2%, 7%, and 10% respectively:

Compound Interest example 1

In 30 Years with $100 monthly deposits:
Future Value @ 2% Annual Return – $49,272
Future Value @ 7% Annual Return – $121,997
Future Value @ 10% Annual Return – $226,048

Not necessarily kick you in your crotch and spit down your neck amazing, but you get the idea.

Now, let’s say you can miraculously eliminate $200 worth of your frivolous spending.  You cut back on shopping, you eat out less, you decide to carpool, or maybe even decide to give up on lattes or frappacinos.  Now you have $300 to sock away!  Using the same ANNUAL RETURN of 2%, 7%, and 10% respectively we have:

Compound Interest example 2

In 30 Years with $300 monthly deposits:
Future Value @ 2% Annual Return – $147,817
Future Value @ 7% Annual Return – $365,991
Future Value @ 10% Annual Return – $678,146

This is more like it!  Not exactly the best retirement figures, but it definitely sells the idea of how compounding interest works.

Now let’s say that there is some type of outside force out there that will double your contributions for free.  For every $1 you put in, they put in a $1.  Crazy right!?!?  If you’re thinking “Parents”, please think again (although that would be nice).  That something is called company match (if your company does not provide this, then obviously it doesn’t apply to you).

Here’s the thing, we all know what it is (at least most of us), but why aren’t we young folks taking advantage of it.

Though the vast majority of eligible baby boomers participate in their 401(k)s, less than a third of workers 25 and under are contributing to these employer sponsored retirement plans. Even worse, only 4% of young workers are maxing out their workplace retirement plans, according to a recent survey by the tax information service CCH. (SOURCE)

I understand that most of us are above 25 (points at self), but as long as I feel young, I will always consider myself young.  With that said, take full advantage of compounding interest.  Start small if you have to with $50 or $25. It’s just one simple strategy to building wealth.

*SAVINGS TIP: I would have my savings and checking accounts at two entirely different banks. That way, if you are running low on the checking side, you won’t impulsively transfer the savings right back into your checking account.  I have helped far too many people in debt and this is a common denominator amongst ALL of them.

Are you a saver?  What is greater, Compound Interest or Sliced Bread?

Khodaa haafez (persian)

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3. My Star Wars Collection Was a Waste