Retirement (MP) Understanding the power of compound interest can enhance your earning power. The younger you are and the more years you have in front of you can be a significant factor in earning potential. But, even so, knowing how compounding interest works will allow the late bloomers to pile up wealth in no time.
Whatever your age, you can get on the right track, enhance your earning power, and build wealth by learning three rules of strategic retirement investing.
How Compound Interest Grows Your Money
1. The Interest
Did you know by saving $1, and compounding it will soon turn into many dollars. Compound interest happens to a helping friend on the road toward financial freedom. Let’s see how compounding interest helps: Let’s say you have saved $2,500. Now let’s apply the rules of compouningd interest to that $2,500. You decide to invest it in a certificate of deposit (CD) at your bank, which pays you 5% interest per year, compounded annually.
Year One – $2,625
Year Three – $2,894
Year Five – $3,191
Year 10 – $4,072
Year 15 – $5,197
Year 20 – $6,633
Year 30 – $10,805
You can see by putting your money in a bank CD at 5% annual interest, and compounding doubles it in 15 years, and quadruples it in 30 years. And that’s what happens when you earn 5% interest on your money compounded annually. You can earn even more money by finding a CD with interest that compounds quarterly or even daily. Now raise that number to $5,000 at 5% interest in a CD alone, annually. Do the math with Investor.gov’s compound interest calculator.
Chances are you’re going to live to be age 90, and maybe even longer. That’s a lot of time to make up for not investing earlier. Of course, the younger you are and the more years you have to invest, the more time you have to make up for any investment mistakes. But whatever your age, you’re never too old to:
A. Get on the right track
B. Enhance your earning power
C. Learn to build wealth
D. Learn the rules of strategic retirement investments
Investments markets are always moving, either up or down, they never stand still. Sometimes there are “bull markets” when stock prices keep going up and “bear markets” when they keep going down. Yet, we live in a historical growing economy and over time evidence demands that economic growth keeps the markets climbing. What history of the markets tells us is that you can predict how much you’ll earn from any given investment.
You won’t earn the same return each year because some years your investments will be up and others they will be down. But you aren’t investing your money for one year. You’re investing money for many years –in fact, for the rest of your life. And history tells us that when you average the performance of your investments over many years, this is how much they will return each year.
- Stocks 12%
- Bonds 8%
- CDs 5%
Example: Say you invest in a mix of stocks, bonds and CD’s. And overtime, that mix of investments returns an average of 10% per year. Now let’s see how much that $2,500 you saved will earn when your put time, compounding and history all on your side:
Year One – $2,750
Year Three – $3,328
Year Five – $4,026
Year 10 – $6,484
Year 15 – $10,443
Year 20 – $16,819
Year 30 – $43,624
And that’s the kind of wealth you can build if you just take $2,500, invest it and let compound interest, time and history all work for you. Just imagine how fast your wealth can grow if you add another $2,500 as suggest up top and another $2,500 the year after. Now imagine how fast your wealth can grow if you maximize use of all the tax-sheltered investment plans available to you. Now your wealth is growing, year-after-year, and you won’t have to share any of it with the Internal Revenue Service (IRS) for years to come.
Understand more about compound interest at Better Money Habits.