advantage of compounding interest Scarborough Capital Management

The Younger You Are, the More Sense it Makes to Save

The sooner you start saving for retirement, the better off you’ll be.

And that’s not just because you’ll have longer to stash money away. It’s because you’ll be taking full advantage of compounding interest to let your finances grow exponentially. Your money will literally be making more money for you while you sleep (and also while you’re awake).

Here’s how it all works:

We Heard You Like Interest

Compounding interest essentially means you’ll gain interest on your interest. You can check out the formulas and the math at work, if you’re into that sort of thing, but the important thing to understand is that it will grow your savings much, much faster than simple interest.

That’s because you’re earning interest on top of your interest, instead of just on the money you put into the account (known as the principal).

For example, let’s say you put $100 into a savings account that gets 6 percent simple interest (so it’s not earning you money off the interest). So that’s a principal of $100, growing at 6 percent of the principal ($6) every year. In a year, that’s $106. In 20 years, that $100 would have grown to $220. That’s nice, but compounding interest is nicer.

If you put that same $100 into an account earning 6 percent compounded interest, it would still just earn $6 in that first year. But then, instead of earning another $6 in year two, it would earn 6 percent of $106. That’s $6.36. Sure, maybe that’s not that exciting yet, but each year it will keep earning more and more, because it’s including your interest earnings in the equation.

After 20 years of compounding at 6 percent interest, that $100 will grow to $320.71— a whole $100.71 more than you would have earned on simple interest alone. 

Now, let’s say you put another $100 in that same savings account every month. After 20 years of 6 percent compounding interest, you’ll have a savings account worth $44,142.71. Kinda weird that it still ends in 71 cents, right? 

If you started this account when you were 25 years old and let it run until you turned 65, you’d have more than $185,000 in your savings — just from stashing away $100 a month in a fairly typical savings account.

Obviously, not everyone can afford to save $100 a month, but save what you can, and make it a priority. If that’s $10 a month, do it. If it’s $1,000 a month, great! Do what you can, and your future self will thank you for it.

Play around with this investment calculator to see how your savings can turn out. 

 

It’s never too early to plan for the future. Contact Scarborough Capital Management and get the conversation started. 

 

Forget You Have Money

This may seem like a strange tip, but it’s really good to pretend that your savings account doesn’t exist.

Since you get the most benefit from compounding interest by just letting it grow, any money you take out of your account is just going to cut into your future earnings. Set up a direct deposit to your savings account (if possible) and just let it run on autopilot. If you get a raise, give your retirement deposits a raise as well. You’ll reap the benefits when you retire.

But what if something unexpected happens, and you need to rely on your savings? 

That’s what your emergency funds are for. If saving for retirement is the best thing you can do for your future self, setting up a separate emergency account is a close second.

Actually, let’s call it a rainy day fund instead of an emergency account. That just sounds nicer, right?

Start saving in your rainy day fund until you have at least three to six months’ worth of living expenses stashed away. Once you’re comfortable with your rainy day fund, start sending those contributions to your primary savings account instead so they can help feed into your compounding interest.

Your rainy day fund gives you a cushion in case something unexpected and expensive happens in your life. It lets you cover those costs without taking on unnecessary credit card debt or dipping into your primary savings and messing with your retirement money.

Start Saving Now

So, it’s pretty clear that saving early and saving often are good strategies for putting money away for retirement, right?

So, start doing it. Find a bank or credit union that offers a savings account with compounding interest, and start saving. Even if you can only afford a few dollars a month, that is so much better than nothing.

Same with your emergency funds — they may grow slowly, but at least they’re growing.

Plan your budget with your future in mind, and start saving whatever you can afford to put away. With time (and the magic of compounding interest) you’ll be well on your way to a comfortable future.

 

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