We all know that someone who doesn’t believe in putting their money away in a savings accounts. They usually think that financial institutions are a scam or are just trying to take their money. Instead, they sit on their money, it could be under a mattress or stuffed away in a sock drawer where they believe it could be safely tucked away for anytime.
While sitting on savings might seem practical, it’s actually costing you money. The longer you sit on your cash the longer you’re missing on having your money work for you.
Today, we are going to show you about the power of compounding interest and why it literally pays to save.
The Power of Compounding Interest
Compound interest is interest calculated on principle and on a previous deposit or investments’ interest.
You might have heard the classic question: would you rather take a million dollars now or a penny today doubled for a month (30 days)? A majority of people when asked this question, generally say they’d take the million right now (who blame can them right, it’s a million dollars). However the trick to this question is the power of compounding interest.
If you take a penny a day and double it each day for 30 days, you’ll actually end up with $5,368,709.12. Which is a heck of a lot more than a million dollars. You see the penny’s value is doubled each day, which it basically earning interest on itself.
While doubling an investment a day might seem amazing, there really isn’t anything out there (at the moment) that is going to give a 100% return daily. However, this example can be applied to a more practical scenario.
To explain the power of compound interest a little better, let’s look at the following example:
Assume an initial investment of $1,000 that earns a 10% annual interest. Over the first three years, the amount of interest earned is calculated as follows:
Year 1: $1,000 x 10% = $100
Year 2: $1,100 x 10% = $110
Year 3: $1,210 x 10% = $121
The total savings after three years is $1,331 which is equal to the initial investment of $1,000 and the total of all the interest ($100 + $110 + $121 = $331). The $331 is the compounded interest.
If you want to, you don’t have to just sit on your investment, you can actively contribute to it, which in turns aids in your compounded interest. By making weekly or monthly deposits into your account, you are contributing to the growth of your investment. Doing so can speed up your growth, as you’ll notice that the larger the investment, the larger the compounded interest.
The Rule of 72
The rule of 72 is a simple formula that estimates how long it will take to double your initial investment. Divide 72 by the interest rate, in percent, your savings account offers. The result is the number of years in which your savings will double. If you have a 2% interest rate, 72 divided by 2 equals 36. So, for this example of a 10% interest rate, your savings will double in 36 years.
The longer you save, the more interest compounds over time. It is better to start investing now so you can reap the benefits later.
Why Compound Interest Is Important
The secret of future financial success is to start saving as soon as possible. Even a small amount of money can generate wealth over time when compound interest is involved. You might think compound interest doesn’t benefit you much, but when you consider a long-term investment even lower interest rates can significantly grow your investment over time.
Start saving as early as possible, to enjoy the benefits later on in life. Remember that it is never too late to start saving, but the sooner you start the longer you will have for your money to grow.