INVESTINGBUDGETING

Financial Besties Time and Compound Interest

Time and compound interest are two peas in a pod. Let’s break down what compound interest is and the positive relationship that it can have with time.

What is Compound Interest?

Interest is the idea that when you put money into a savings account, you earn a small amount of money each day it remains in that account. Usually, this interest is given to you at the end of each month or quarter (cycle) as a percentage of your average daily account balance. Compound interest is the money that you earn as interest on the original deposit plus the interest you earned the previous cycle. This means that instead of only earning money as a percentage of your initial deposit, you slowly earn more interest each cycle as your savings continue to accumulate.

It can also be viewed as interest earned on interest. An equation exists to calculate compound interest, but I find it easier to use a calculator like the one on Investor.gov to help you estimate interest potential. A link to that calculator can be found in the resource section below.

Time Equals Money

Whether in a savings account, certificate, or investment account, the longer you are able to put money away, the larger the potential for earnings becomes. This is exactly why it is so important to start saving for retirement at a young age. The sooner you are able to save for retirement, the longer it has to grow and accumulate compound interest, allowing you to use time to your advantage.

The same is true for investments. The possibility of greater earnings increases the longer you are able to leave money in an investment. The opposite is true when it comes to loans, especially with credit card debt. It can take a very long time to pay debt off while making the minimum payment as interest continues to accrue. This relationship between time and money has its pros and cons.

The Rule of 72

Finding the best place to invest your money can be overwhelming. Before you take the time to open new accounts to invest your money, you can use the rule of 72 to estimate how long it will take to double your money. This rule works in two ways. First, you can divide 72 by annual percentage yields (APY) being offered to see how many years it will take to double your money. So, for example, if you have $2,000 in an account earning 4% APY and you want to double that to $4,000, take 72 divided by 4, which would estimate 18 years to double your money.

This can work another way as well. Say you have $10,000 to save and would like to see this money double in 10 years. You would take 72 again, divide it by 10 years, and this tells you that you would need a 7.2% APY to make that happen.

Your future self

Starting to list the goals and dreams that you have for your future can help you recognize what future savings will be needed. I highly recommend sitting down with a financial planner or advisor; they will be able to guide you toward investing your money in the place that best fits your vision for your life.

Sources

• https://www.investor.gov/financial-tools-calculators/calculators/compound-interest-calculator