The Power of Compound Interest
No matter what your financial situation is, if you haven’t gotten into the habit of saving every month, then you’re leaving a significant amount of money on the table. With how compound interest works, an initial investment can grow quite a bit over a period of decades, especially if you continue to add to that investment with consistent saving.
How Compounding Works
The way compound interest works is simple enough to understand. Instead of only earning interest on the amount you deposit, you also earn interest on the previous interest you’ve earned. Over a period of months or even years, this doesn’t make a huge difference. This leads people to mistakenly believe that the only way to save a large amount of money is to have a high income.
However, over a period of decades, compounding can result in big gains on your deposits. Let’s say that you put $5,000 in an investment account that has monthly compounding and earns 8-percent interest annually. After 20 years, the account balance will be well over $20,000. After 30 years, it will be approaching $60,000, and by the 45-year mark, it will be almost $180,000.
As you can see, compounding results in a much larger total return the longer you have the account, which is why it’s so important that you start saving money early on in life.
Saving Money Every Month
Although you can grow a small amount of money if you leave it in an investment account for decades, the real power of compounding is when you continue to make deposits into the account over those decades. For example, with the same investment account in the example above, depositing $5,000 every year instead of just $5,000 initially will result in an account that’s worth over $2 million after that same 45-year period. You’ll have invested only $225,000, meaning the account will earn over $1.8 million in interest.
While $5,000 per year sounds like quite a bit of money if you haven’t made saving a habit yet, it’s only 10 percent of a $50,000 yearly salary, and financial experts recommend that you save at least 10 percent of what you make. And that’s just an example. The point is saving any amount is better than nothing. You may not be able to save $5,000 per year when you start, but as your income grows, you could eventually find yourself saving more.
There’s No Time Like the Present
It’s not difficult to make saving money a habit. Set up a budget with your income and expenses, and then commit to putting at least a certain amount into an investment account every month. Make that the first thing you do every time you get paid so you avoid the temptation to spend your money.
Procrastination is the biggest obstacle when it comes to saving. People keep telling themselves that they’ll start saving when they make more or when they have more time to look into investment accounts. But each year you wait is one year taken off the back end of your investment account, which is when it grows the most. Even if it’s just $50 or $100 every month, the best thing you can do for yourself is take that first step.