Dear Daughter,
So here’s the deal, Compound Interest is THE best friend of anyone saving money.
Compound Interest also works much better when you have more time to save, as you’ll soon see. This is yet another reason to begin saving early in life.
The really cool part about Compound Interest is that it works best if you do….well….. almost nothing! In fact, the only way this magic can work is if you do, almost nothing. The funny thing is that as we get into different ways to make money with your money in future Memos, most of what you do is….. almost nothing…..for long periods of time. I know it sounds simple but believe me, sometimes it is incredibly hard to do!
Remember, I say “almost nothing” for a reason. You have to make the decision to save your money and then let it grow. The “almost” is you making that decision to save. The “nothing” is you letting your money Compound and grow without withdrawing it.
Okay, based on the Memo regarding ~ INTEREST, you now understand what simple Interest is, right? As a reminder, it is simply the money you make by letting someone else use your money for a set period of time. Well, Compound Interest kicks this up a notch!
Are you ready to learn about the magical world of Compound Interest? I know you are eagerly nodding your head with approval!! Okie Dokie artichokie……here we go!
The easiest way I’ve found to understand this simple concept is just to think of Interest earning Interest.
Remember in the Memo regarding ~ INCOME when your employees earned $5 for doing their work? Well, if you did almost nothing with that $5 and left it in the bank, said bank would be paying you Interest on $55 the following year instead of your original $50!
Let’s do some quick math to make this easier to understand:
- $50 earning 10% Interest For The Year (also called the Annual Percentage Rate or APR) equals $55. ($50 x 1.1)
- $55 at 10% APR equals $60.50 at the end of year 2. ($55 x 1.1)
- $60.50 at 10% APR equals $66.55 after year 3. ($60.5 x 1.1)……and so on.
- And there you have it! By doing, almost nothing for just 3 years, you’ve now earned $16.55! (66.55 – 50)
Right about now you are saying something like this to yourself….
“Wow, that’s sooo incredible! I earned a whopping $16 in 3 years by listening to my dad’s stupid advice”.
Okay, smart girl! Let’s look at it from a different perspective.
For giggles let’s say you are 22, just graduated college, and have landed a decent starting gig at $50k per year. You, at least, take some of my advice and decide to save 20% of what you make every year.
That is $10k per year you are going to save. This doesn’t take into account getting raises or promotions and earning more money. Basically, what I’m saying here is that this constant $10k is a conservative estimate.
With this conservative estimate, by the time you are 40, you will have accumulated $496,536 (almost half a million smackeroos)! Keep in mind, you only contributed $170,000 of your own money. The rest is Compound Interest Baby!!
I love playing around with Compound Interest calculators to keep me motivated to save (money nerd). I particularly like the one on Bankrate.com. Go check it out.
Remember when I said that having more time to save makes Compound Interest work better for you?
Consider this, if you waited until you were 30 to start saving, you would only have $201,249 by the age of 40. That is almost $300k less because you waited just a few years.
DON’T WAIT!
I learned a great deal from the book entitled “The Compound Effect“. This book goes into much more detail and it is something I think you should read in middle or high school. Please keep it as a reference and refer back to it when you need a bit of motivation to stay the course and do…..almost nothing.
Love, Dad
