Compounding Interest – Why You Should REALLY Start Saving Now

In my previous post, I illustrated the power of time and compounding interest.  In my example, I showed what periodically putting money into a savings account bearing .8% interest can do over time.  This .8% figure is what a popular, large online bank is currently yielding in its savings accounts. As I illustrated, here is how your money could grow in a savings account:

Amount Saved Monthly 5 Years From Now 10 Years From Now 20 Years From Now 30 Years From Now
$50 $3,601.81 $6,248.53 $13,017.30 $20,349.62
$100 $6,123.62 $12,497.05 $26,034.59 $40,699.24
$200 $12,247.23 $24,994.11 $52,069.18 $81,398.48

It stands to reason that if .8% interest can provide you with significant growth over time, higher interest rates can accelerate that growth.  So, where can you find higher interest rates?

Your Money Working Harder

The stock market is a market in which shares of company stock are traded.  The stock market allows organizations to raise capital by selling shares and allows individuals to acquire a piece of ownership in a company.  Individuals who invest their money in an organization can gain money if the organization performs well.  The following are the average returns of large stocks for given periods of time as of October 11, 2011 according to usatoday.com (http://www.usatoday.com/money/perfi/columnist/krantz/story/2011-10-17/rate-of-return-for-stocks/50807868/1):

  •  5 years:  1.3%
  • 10 years:  2.0%
  • 20 years:  7.9%
  • 30 years:  10.5%

Investing in a single company does carry significant risk, though, as the invested dollars increase and decrease based solely on one company’s performance.  If the company performs well like Apple Computer, Inc. has in recent history, its stock could increase over 100% in a matter of months.  On the other hand, if a company performs poorly or engages in fraudulent practices (think Enron Corporation), your shares could become worthless and your dollars evaporate.

Mutual funds offer a way to purchase shares of stock while hedging against this type of risk.  Mutual funds are a collection of stocks, bonds, or other securities and can contain a single security type, or can contain a mixture of different securities (i.e., a mutual fund could contain 85% stocks and 15% bonds).  If the figures above caught your eye and you wanted to invest in a mutual fund that contained stock belonging to large companies, there are numerous large cap (short for capitalization; think “capitalization = size”) mutual fund offerings to choose from.  Two popular options are the  Spartan 500 Index Fund offered by Fidelity Investments and the Vanguard 500 Index Fund offered by Vanguard Investments.  Both of these funds track the Standard and Poor’s 500, a list of the largest publicly-traded U.S. companies.  Using the rates of return listed above, here is how different amounts invested monthly would grow over time:

Amount Invested Monthly 5 Years From Now 10 Years From Now 20 Years From Now 30 Years From Now
$50  $3,079.02 $6,569.83  $27,154.92  $108,528.90
$100  $6,158.04 $13,139.67  $54,309.85  $217,057.79
$200  $12,316.08 $26,279.33  $108,619.69  $434,115.59

As you can see, small amounts of discipline exercised on a regular basis can be hugely rewarding in the long run.  Compare the first table above to this table and see the incredible difference interest rates can have on your savings and investments.  If you are already saving and investing on a regular basis, see if you can put a little more away each month.  If you are not already saving or investing, now is a great time to start.

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