The Secret to Financial Security: Compound Interest
September 5, 2019
Well, it’s not exactly a secret, but compound interest plays a pivotal role when planning for your retirement. Or simply working toward financial security. Fondly referred to as “interest on interest,” this concept allows you to save more without necessarily contributing more. As long as you start early and properly invest your funds. If you’re unsure about what this particular financial term means or how to build it, you’ve come to the right place!
Remind Me Again, What’s Compound Interest?
Unlike simple interest, which is calculated from the money you’ve deposited or loaned—also called the principal. Compound interest allows you to accumulate interest and add it to the principal before calculating additional interest. Basically, allowing the amount you’ve saved or invested to grow at a faster rate than it would with regular interest.
But all compound interest is not created equal. Besides the interest rate, you should also ask about the compounding periods associated with a specific investment or account. As a general rule, the more frequent these periods, the more you’re able to benefit from the “miracle of compound interest.” To help you better understand the difference, we’ll share a few examples.
Since money talks, we figure that the best way to explain this financial concept is with monetary amounts. For our first example, let’s assume you have $10,000 to invest and you don’t plan on touching these funds for at least 20 years. If you have access to an account with a 5% interest rate that’s compounded annually (or once per year), then at the end of those 20 years, you should have over $26,500. That’s without contributing anything additional within that time frame.
However, if you have the option to compound your investment monthly instead, you’ll have well over $27,000. Because the interest is being included far more frequently. Now, we won’t bore with you overly complicated mathematical equations. But if you want to play around with various amounts and interest rates, we recommend you use a reliable compound interest calculator online.
Framing Your Financial Security
Now, it’s time to put this tool to use in your everyday life. Not only will compound interest play a key role in your retirement savings—provided you do it right. But also, you’ll establish better financial security by staying out of debt. After all, compound interest can work both for you and against you! This is the primary reason why only paying the minimum credit card payment each month will cost you far more than what you owed in the first place. It’s also why we recommend that college students at least pay the interest on their student loans as it accrues. Even though it seems like a minor charge now, after 10 years of compounding interest, it’ll grow.
Ideally, you want to strike a balance between paying extra toward any existing debt, while also contributing to your savings early on. We know this can lead to a couple of lean years in the beginning of your career. But the difference it’ll make toward your long-term financial security is astounding. That’s the real “miracle” of compound interest.
For more information on how you can maximize compound interest in your life, please contact Bounds Accounting & Tax Services, LLC. We’ll be able to review your current accounts and recommend steps you can take toward financial security. The sooner you start, the better off you’ll be!