“A penny saved is a penny earned”, the old saying goes. But if that penny is saved using compounding interest, you could be earning a whole lot more.
Compound interest is a powerful effect that time can have on money if you’re investing your resources in the right places. Most people know that when you put money into a savings account, it earns a certain amount of interest. These days, that interest is usually fairly low, often less than 1%. But each and every month, your bank will drop that little bit of money into your account. It’s yours! That’s interest.
If you leave that extra money in the account, it too will earn interest. So your second month, you’ll actually receive a larger interest payment from the bank, because you’ll be getting paid on your first deposit PLUS the interest you earned last month. This is compound interest.
Let’s look at a simple example:
You deposit $1000 into an account that earns your 1% interest every month. At the end of your first month, you’ll receive an interest payment of $10 ($1000 X 1%), giving you a total of $1010 in the account. Next month, the interest payment would be $10.10 ($1010X 1%), bringing your total to $1020.10.
You can imagine how, over time, the effect of compounding interest can have a huge impact on your savings. Any money that you don’t plan on touching for a while (think about your retirement account) has the potential to be significantly boosted due to compounding over the many years between now and retirement.
Obviously, if you take money out of the account, you’ll hamper the compounding process. In our previous example, if you took the $10 out of the account at the end of the month, you would not see any compounding. You would just perpetually receive the same $10 payment each month, instead of seeing an ever-increasing sum.
Book an appointment to talk to your financial advisor today and discuss how compound interest can help you reach your financial goals.