Saving is the process of deferring consumption now so that you can have a greater amount to spend later, or have funds to draw upon when you no longer have a regular income. Forget about consumption. Thanks to the power of compound interest, saving will set you free!
What Is Compound Interest?
Compound interest is the money that you receive on both principal and earned interest. Compound interest accelerates your returns. Let’s put this into an example. Say you purchased a $1,000, 5 year Certificate of Deposit that carries an interest rate of 2%. The interest compounds daily, which means that the interest is calculated every day for five years.
- Your principal is the $1,000 you initially invested.
- You earn an interest rate of 0.005479% daily. That’s 2% divided by 365.
How Compound Interest Works
| Day | Balance |
|---|---|
| 1 | $1,000.05 |
| 2 | $1,000.11 |
| 3 | $1,000.16 |
| 4 | $1,000.22 |
| 5 | $1,000.27 |
Here is what’s happening:
- On day 1, you earn 5 cents interest on $1,000 of principal.
- On day 2, you earn roughly 6 cents interest on $1,000 of principal and 5 cents of interest.
- On day 3, you earn interest on $1,000 of principal and 11 cents of interest.
- The process continues on until the term of your CD matures. The numbers shown in the chart above are rounded and reflect a small time period, so you won’t see much change. However, over a long time period, you will start seeing the power of compound growth.
Year End Balances Of $1,000 Five Year 2% CD
| Year | Balance |
|---|---|
| 1 | $1,020.20 |
| 2 | $1,040.81 |
| 3 | $1,061.83 |
| 4 | $1,083.28 |
| 5 | $1,105.17 |
Through daily compounding, you earned an extra $5.17 at the end of five years. Yes, it’s a very small sum. But we’re using a very small example here. If you started investing today with a sum of $500 and continued investing $500 every month, assuming a conservative 6% return, you would have $505,682 in 30 years! That’s no sum to laugh at.
Earn Your Freedom By Saving
Remember Money = Time? In five years, $105.17 in interest was earned in the example. That means by saving $1,000 (assuming a wage of $20 per hour), 50 hours of time was saved and an additional 5 hours of time was created.
When you are in debt, you are a slave because you owe someone else time. Interest builds on debt, much like it does with savings. When interest builds on debt, you owe an increasing amount of your life to the debtor. With debt, interest is your enemy. Interest increases the amount of time that you will be a slave. You can set yourself free by paying off your debt and saving.
By saving, interest becomes your friend. Interest earns you additional time that you would not normally have or be able to make. Interest makes money work for you 24 hours a day, 7 days a week to make you more time. The more time you save, the more time you can create. When you have banked the amount of time (money) for yourself that is equivalent to the time (money) that you will use during remainder of your lifespan, you have set yourself free. You will be free to do what you please and live life on your own terms.
How would your life be improved if you were debt free? Do you plan on improving your saving goals? How much do you think will be enough?
Talk to me, Goose.