“What is compound interest? It’s just easy math. When you start saving, that money earns interest. The interest makes the pot of money bigger, so it starts accruing more interest. Over a lot of years, that little bit of interest early in the process makes a big difference.”
The key word in that last sentence is “early.” If you don’t start early, more than likely you will miss out on compound interest. And you don’t want to be caught at 45 years old asking yourself “What is compound interest? Is that some tricky financial formula?” No. Compound interest exists only if you start saving early in your life. I started saving early in my life, but I was not patient.
There was a time when I actually earned 5% on a savings account. That was not unusual. At other times and with other accounts, people could make up to 7% even 8%. What does that look like in terms of account sums at the end of the year? Let’s take a look.
Let’s say you start by depositing $500 into a savings account, an account that pays out 3%. 3% of $500 is $15. That’s nothing. $15 is not much of a reward for saving your money. The initial $500 is just a start; it’s just to open your money-making account. So far that’s not compound interest.
You can’t make just a single deposit. You’ll need to make monthly deposits, regular deposits for compound interest to work. So start with $500 but deposit $250, or more, each month. $250 x 12 = $3,000 for the year. 3% x $3,000 = $90, which brings your annual balance to $3,090. That’s at the end of year 1.
Year 2 will look different. For you are starting the year out with $3,090. As you continue to add the $250/month to your account, you can look forward to $6,090 x 3% = 182.70. Add the $182.70 to your $6,090 and you’ve got $6,272.70. This is after 2 years. Imagine if you added money to your monthly deposit, say, an extra $100 per month or more, you would be closer to $10,000 after just 2 years. Are you getting this?
Compound interest is a serious wealth-building strategy. It’s a formula that works. Don’t tinker with the productive genie.
Year 3. Now you’re starting out with $6,272.70. Again, you’re depositing $300, or more, per month. 12 months x $300 is $3,600. Add that $3,600 to your balance of $6,272.70. 6,272.70 + 3,600 = $9872.70. After 3 years of regular deposits you will find yourself being in the possession of nearly $10,000. And it only gets better from here.
Year 4. $9,872.70 + $3,600 = $13,472.70. Multiply that times 3%. $13,472.70 x 3% = $404.14 in interest earned. Add that $404.18 to your balance of $13,472.70 = $13, 876.88. Now you’re getting closer to a down payment for a house. Remember, this is a depositing schedule that has not hurt you one bit. Plus, you may have received a few raises over these 4 years, which you could easily add to your monthly deposits to increase your compound interest.
This plan is elegant. It is no mystery. It works. Has worked since its inception. Stick with your vision. Stick with your financial goals. Don’t withdraw this money. Don’t use it to buy a new car. Don’t use it to take a Hawaiian vacation. This is your future. Don’t mortgage it for a few hours of pleasure over the weekend or during a week in the summer. What makes the interest compound is your ability to leave all the accumulated interest in your account. Once you withdraw any amount, you are surrendering your ability to earn compound interest.
You can use this calculator to help you get started.