Which Way is the Financial Wind Blowing in Your Life?
- Monday, August 08, 2011
When you’re in your teens or early 20s, it can be really hard to think about something as abstract as retirement and to put away money for such a vague distant goal. But your age is a huge advantage in building wealth. Huge.
The younger you are the more you can take advantage of what I call the financial fan. The more common name for it is compound interest. When you earn interest on money that you put into savings or an investment, that interest earns interest, and then that interest earns interest, and on and on. Interest earning interest is what’s meant by compound interest.
The thing is, compound interest can either work for you or against you.
Financial Wind in Your Face
I once heard someone say she had $6,000 of credit card debt. Shrugging her shoulders, she casually described it as “not much.”
Not much? If she takes on no more debt and makes the minimum required payments each month, it could take her over 42 years to pay off that debt! That’s one stiff financial breeze blowing in the wrong direction.
Now let’s see what happens when we get the wind blowing in the right direction.
Financial Wind at Your Back
Let’s say you put $100 a month into an investment and earn 8 percent interest per year. After the first year, you’ll have invested $1,200. That’s $100 per month for 12 months. And since you earned 8 percent, you’ll have made about $45 in interest by the end of that first year. I know – you’re not impressed. Not yet.
Let’s check in at the ten-year mark. At that point you will have put in $12,000, but it will be worth nearly $18,300. Not bad.
But look at what happens after 20 years. If you’ve been faithful at investing $100 each month, you will have put in $24,000. But if you’ve been able to earn 8 percent per year, your $24,000 will have turned into $58,900. Wow. Now you’ve earned more in interest than you’ve contributed.
Let’s say you stick with this for 45 years. You will have invested $54,000. That’s $100 per month for 45 years. Again, assuming an average return of 8 percent per year, your $54,000 will have turned into over $527,000! Isn’t that amazing? Now that’s some powerful financial wind in your sails. That’s the power of compound interest.
Put Time on Your Side
The key to taking advantage of compound interest is time. Here’s one more example to drive home this point.
Let’s say you invest $200 a month starting at age 20, but have to stop after 10 years. A friend of yours doesn’t start investing until age 30, but then goes on to invest $200 a month for the next 35 years. You both earn 8 percent per year on your money.
By age 65, you will have invested $24,000. He will have invested $84,000.
You’ll have $596,000. He’ll have $459,000.
What’s the key to maximizing compound interest? Time.
If you’re a high school or college student with a part-time job, you’re young enough to get the absolute maximum benefit from compound interest. Get the wind blowing at your back.
If you’re older, better to get started at age 35 than 40, and better to get started at 60 than 65.
Matt Bell is the author of three personal finance books published by NavPress, including the brand new "Money & Marriage: A Complete Guide for Engaged and Newly Married Couples." He teaches a wide variety of workshops, including MoneySmart Marriage, at churches, conferences, universities, and other venues throughout the country. To learn more about his work and subscribe to his blog, go to: www.mattaboutmoney.com.
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