The Power of Compound Interest (and Why it Pays to Start Saving Now)
By Michael Vaughn, CFP®
You’ve likely heard the concept: don’t work for money, make it work for you. This concept isn’t new, but compound interest is a relatively new phenomenon. Albert Einstein called it “the greatest mathematical discovery of all time,” and it has changed how we build wealth and has actually made wealth-building more accessible for millions of people. The beauty of compound interest is that anyone can benefit from its advantages as long as they’re willing and able to invest their money.
How Compound Interest Works
Simply put, compound interest means you earn interest not only on a principal amount, but also on the interest you receive. For example, if you invest $100 and earn 10% interest annually, you will then earn interest on $110 during the next compounding period without additional contributions. Then you would earn interest on those earnings, and the cycle would continue.
This compounding effect allows wealth to grow exponentially rather than linearly. There are multiple factors that influence the amount an investment will grow through compound interest, including:
- The interest rate earned on your investment
- The frequency of compounding
- The amount of time your money has to grow
Naturally, the higher the rate of interest, the more your money will grow. But higher interest rates are often accompanied by higher risk. Additionally, higher frequencies of compounding will result in greater growth. And because compound interest growth is exponential, the amount of time an investment has to grow is perhaps the most important factor when it comes to building wealth.
The Time Value of Money
The time value of money concept states that money you have now is worth more than the same amount of money in the future. This is because money has the power to earn interest, so the earlier you receive and start investing that money, the more time it has to grow exponentially.
Consider the example from above: If you receive $100 today and invest it at a 10% interest rate compounded annually, you would have $110 a year from now. Therefore, that $100 is worth more to you today due to its earning potential over time.
The Miracle of Compound Interest
To truly understand the awesome power of compound interest, suppose you are able to save $2,000 a month. If you saved $2,000 a month for 30 years in a non-interest bearing account, you would have $720,000 at the end of the savings period.
But if you invested $2,000 a month into a tax-deferred retirement account that earned 10% for 30 years, you would have $3,947,856.54. (1)
Conversely, if you invested $2,000 a month for just 15 years at the same annual rate of 10%, you would only have $762,539.56. That’s a difference of more than $3,000,000. Without a doubt, the longer amount of time you’re able to invest, the more drastically your wealth can grow.
This is why you shouldn’t wait another day to start saving in compound interest investments.
Learn More About Compound Interest With a Trusted Partner
Your financial and retirement planning isn’t complete if you’re not taking advantage of the power of compound interest. We at Pinnacle Family Advisors know that financial matters can get confusing and maybe overwhelming, so check out our YouTube video where we discuss compound interest further.
If you’d like more help understanding and capitalizing on compound interest opportunities, let us help you bridge the gap. We use the latest financial techniques, solutions, and one-on-one education to bring clarity and confidence to your financial life. If you’re ready to schedule your complimentary introductory meeting, email me at [email protected], call (417) 351-2942, or use my online calendar.
Michael Vaughn is a Certified Financial Planner™ (CFP®) and Vice President at Pinnacle Family Advisors (PFA) with 20 years of industry experience. Before joining the PFA family, he served clients with investment management and retirement planning at The Mutual Fund Store for 14 years. Michael graduated from Missouri State University with a bachelor’s degree in business administration and management and earned his CFP® designation in 2004. He also served 20 years in the Missouri National Guard, retiring in 2007 as a Major. He currently volunteers on the board of directors for Good Dads and Fellowship of Christian Athletes. Michael is married to Lori and they have two daughters. To learn more about Michael, connect with him on LinkedIn.