Discover the secrets to building real wealth and financial security.
How Compound Interest Affects Savings
Terry’s nest egg totals over $130,000 but Tim’s is over $206,000. Terry had to save $60,000 ($3,000 x 20 years) in order for her fund to grow to $130,000. But Tim only had to save $44,000 ($1,200 x 37 years) for the same investment to grow to $206,000. Put another way, Tim saved 26% less than Terry, but now has about 59% more money than she does! It almost seems impossible to save less and end up with more; but it is possible due to the power of compounding interest.
When your interest compounds, it’s sort of like double-dipping because you earn interest on your savings and on the interest you already earned. That makes long-term investments grow dramatically. But the only way to take advantage of compounding is to start saving early. When you do that you’ll get a lot more for less, and who doesn’t want that?
How to Make Saving Automatic
In order to kick start your New Year’s saving resolution, I can’t think of a better way to do it than by making it automatic. Payroll deductions for workplace retirement plans are fantastic. Be sure to always contribute to them, especially when your company matches your contributions. If you’re paid by direct deposit, you could instruct the HR department at work to send a percentage of your pay directly to a savings account. Or you can use online banking to set up a recurring transfer so money is automatically withdrawn from your main payment or checking account and deposited into a money market or IRA, for example. That way you don’t have to think about saving, it’s done consistently, and you probably won’t even miss the money after getting into the groove of your new routine.
To sum up, the best way to become a better saver is to make it part of your lifestyle. Don’t put yourself in situations where you could be tempted to overspend. If you don’t have money budgeted for buying clothes, for instance, don’t go to the mall on a Saturday with a friend--go to the park or beach instead. A couple of resources for great saving tips are americasaves.org and choosetosave.org.
Lastly, remember that you can also control what happens to money you don't spend. Put it in a high interest savings account, and don't fall victim to bank fees that will eat away at your money. Find out more about where people usually get hit the most in this episode on money management, and in this Quick Tip about overdraft protection.
Remember that it’s not really about how much money you make, but about how much you vow to keep for yourself. Your financial security is riding on your ability to put off what you could have today, so you’ll have ample financial resources to draw from later on.
Again, this post is the second in our five-part series about taking charge of your finances in 2010. Each article in the series is about a pillar of personal finance—setting goals, saving, investing, being properly insured, and reducing your taxes. Please click on the links to head over to the other episodes.
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