Personal Finance Essentials
Put Compounding to Work for You
Long-Term Saving Requires
Sufficient Returns to Create Wealth
It’s not enough that you save for a long time – it’s equally important that your savings earn sufficient returns so that you can actually create wealth.
The Math Behind the Magic
If you save $100 per month for 30 years, you’ll invest a total of $36,000. If you earn 3% per year in a money market fund or bank CD, you’ll have $58,274. But if you earn 10% per year, you’ll have $226,049. That’s the power of compounding.
The key insight is that money doesn’t grow in a straight line – it grows exponentially. It’s not enough that you save, or even that you save for a long time; it’s equally important that your savings earn sufficient returns so you can actually create wealth.
The Rule of 72
A quick way to estimate how fast your money will double is the Rule of 72: divide 72 by your rate of return, and the result is the approximate number of years it takes for your money to double. At 6%, your money doubles every 12 years. At 10%, every 7.2 years.
Reinvest Everything
One of the most common ways investors undermine compounding is by spending the interest and dividends they earn. All too often, people deposit these payments directly into their checking accounts – and away the money goes. For compounding to work, you must reinvest your earnings, not spend them. This allows interest to earn interest on top of interest, which is the entire basis for exponential growth.