Compound Interest: The Stuff Of Savings Dreams

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How Do People Build Wealth?

There is really only a few options.

  1. Inherit money! Why are you reading this website? Get back to maxin’, relaxin’, and livin’ large! You belong on East Egg and probably had your father give you a small loan of a million dollars to start out. Dope, dude!
  2. Zuckerberg somebody! Get out there and steal someone else’s idea and profit on that sh*t. No mercy.
  3. Come up with a billion dollar idea! Get your Elon Musk on. This is probably the fastest way to make a huge amount of money. You already knew this.
  4. Become a really smart investor. This also takes time. Warren Buffett didn’t just wake up one day to find he had billions in the bank. He makes smart picks, no doubt. But don’t think he’s always beating the market. The only person who can do that is someone with insider trading knowledge.
  5. Invest Money & Let It Grow. This is how most of us do it.

Sorry to bum you out if you were hoping I had an answer to making you wealthy through the first 4 options. If I did, I’d tell ya.

The truth is that most people build wealthy slowly and overtime. That’s how people save for retirement. They invest money as they go and eventually have a sizeable nest egg to retire on.

UNLESS, of course, you don’t invest enough or do so at a young age. Plenty of people can catch up if they work at it. But honestly, no matter how much you think you could catch up later on, there is NO advantage to building wealth better than TIME. The more you have of it, the more wealthy you’ll be based on how much you put in.

Now, you’ve most likely heard this before. That saving money while you’re young is really important. But hey, it’s tough to save money when you’re young. You don’t have as much of it right now. But it’s okay, even a little bit will make a huge difference.

What Is Compound Interest?

Investopedia defines it as, “Compound interest is interest calculated on the initial principle and also on the accumulated interest of previous periods of a deposit or loan.”

Okay, so what does that really mean? It means that when you invest money in the stock market, a mutual fund, a bond, a savings account, whatever…you’ll be paid in interest for investing your money. Stocks go up, you’re making money. Duh, you know this.

BUT, here is what it really means for you. Let’s say you invest $100 in your savings account. The bank pays you 5% interest. (We can only dream, but it works for this example)

After 1 year, you now have $105. ($100 you invested plus the $5 they paid you in interest for the year)

Now is when you start making MONEY ON YOUR MONEY. This is the sh*t if you’re into finance.

After 2 years, you now have $110.25. Wait, shouldn’t I have only $110 if they pay me $5 every year? NOPE. They paid you interest money on the $5 you earned last year too. So lets calculate that. $105 * 5% is $5.25. Add that together to get $110.25. You made 25 cents on the interest money they paid you from year one. Interest on your interest! Get it?

How Huge A Deal This Is

Here is an example of someone saving money and investing in the stock market that assumes a 7% return. (From BusinessInsider)

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Damn, Chris. You’re a millionaire now. You’re all all-star. Get your game on, go play.

So what happened here? Chris invested way earlier than the other two as you can see. This is what I was talking about in regards to time being on your side while you’re young. Compound interest doesn’t make a huge difference until around 40-50 years old for him compared to the others. But after 50, he skyrockets away from those other shmucks. This is because compound interest begins to snowball as you get older.

The Rule Of 72

There is a rule that says to find the number of years required to double your money at a given interest rate, you just divide the interest rate into 72. Let’s try it with Chris’s presumed 7% return. 72/7 =10.29. This means that every 10.29 years, he doubles the total amount of money in his account.

So if he is starting 10 years before anyone else…he doubles his money 1 more time than anyone else. This is where the ending of retirement gives you HUGE gains. Just by starting 10 years earlier, he has the chance to double his money once more before retirement. That is why he has roughly double what Bill has. Chris roughly got to Bill’s number 10 years before he did. Therefore, he doubled his money once more by the time they retired. Instead of 500k, he has over a million. One more time…Damn, Chris. Back at it again with that compound interest.

Do you see how big of a difference it can make to start early? Even small contributions earlier on makes the difference in how much you’ll have later on. And this assumed Chris ONLY had a 7% return. The AVERAGE return of the stock market from 1928 to 2014 was 10%.

How big of a difference would 10% make for Chris? He would have $2.8 Million.

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What if he bumped up his savings to 10k a year instead of just 5k? $5.6 Million

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Imagine The Possibilities!

This is how compound interest works and how people really build wealth. They invest wisely and save as much as they can. And they do it earlier than later.

THE PROBLEM

People in the United States don’t realize this. They push this off until later in life when they think they’ll be making more money and have more to save for retirement. But later in life you’ll probably have a significant other…then a spouse…then some kids. There is always an excuse for not saving. Which is why older generations getting ready to retire are in CRISIS.

Here are some stats to scare you. (Found here.)

  • 45% of Americans have saved nothing for retirement, including 40% of Baby Boomers.
  • 38% don’t actively save for retirement at all.
  • 20% of Americans tap into their 401(k) assets early, either through a loan or withdrawal.
  • 80% of Americans between the ages of 30 and 54 believe they will not have enough saved for retirement.
  • 36% of American adults over 65 are completely dependent on Social Security.
  • 63% are dependent (but not necessarily completely reliant) on Social Security, relatives, friends, or charity at age 65.
  • Social Security is running out of money, and will only be able to cover 77% of promised benefits beginning in 2034.

All those dreams of traveling the world in retirement? Consider them gone if you don’t seriously start thinking about this. There will be millions of American’s who will be just scraping by in their old age. It’s sad and it shouldn’t be that way.

But the reality is no one cares more about you than you. So do yourself a favor and begin saving as young as possible.

The Great News

You’re super smart. Yep. You are. You obviously care about this enough to read this site or have done some digging on your own. You can set yourself up and benefit from the knowledge others don’t have. Start thinking about saving!

In a future article, I’ll tell you where to do it and how to do it.

Thanks for reading! Subscribe to my email list! I’m basing how often I write on the subscribers I get. If you enjoy my content, please help me out and let me know you do. Just joining my email list is all I need to know you’re enjoy the posts!

Until next time!

Matt Dalton

2 thoughts on “Compound Interest: The Stuff Of Savings Dreams

  1. Can you post a blog post about how to start a Roth IRA and how to invest? Specifically minimum requirements of deposits and what you recommend investing in (mutual funds, stock, etc.)

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