Your Money Wants to Give You More Money: A Look at Compound Interest
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Last week we explored the numbers behind credit card debt. This week we’re going to take a look at how compound interest works in your favor by giving you more money for free.
With the ups and downs of the economy over the last twelve months, it’s difficult for anyone to know what to do with your money. Invest in the market and ride the roller coaster, or keep it at home where you can see it and no company will steal it?
The historical returns of the market, mixed with inflation, shows that keeping your money under your pillow isn’t worth it and sometimes you need to take some risk. Inflation has averaged around 3% a year so your money is losing value everyday it sits in your wallet or in a safe at your house.
The power of compounding interest is something that cannot be ignored. At first, it sounds like another boring financial term like dividend or exchange-traded fund, but compounding interesting is your best friend, and when you see it in action it really changes your mind about keeping your money in a safe at home. Picture your money giving you free baby money as a thanks for putting it in a savings vehicle.
Here are two graphs that compare investing and utilizing compound interest, versus keeping money at home.
Andy and Kevin are both 25 years old. Andy invests $1 per day for 40 years, while Kevin keeps $1 a day under his mattress.
Check out the massive difference in sums after 40 years:
| Kevin 25 Years Old Puts $1 Per Day Under His Mattress Average Return: 0% |
| Invested | $14,600 |
| Return After 40 Years | $14,600 |
| Andy 25 Years Old Invests $1 Per Day Average Return: 8% |
| Invested | $14,600 |
| Return After 40 Years | $105,956 |
The difference after 40 years is a total of $91,356!
I’ll admit, it feels discomforting when someone else has control over your money. It feels safer when you can see your money in your house. You know that some greedy CEO in New York City can’t take your money and leave your family with nothing.
However, the numbers above are not even adjusted for inflation. The value of your money loses 3% per year, so an investment in the stock market is a fight against inflation, if nothing more.
With inflation at 3%, Kevin’s $14,600 will actually be equal to $4,317 in 2049. By keeping your money under your pillow for 40 years, it becomes a third as valuable and will force you to make even more money in 40 years to keep up with your lifestyle.
The key is to use your money in your favor. It can’t do anything while sitting in a 0% interest checking account. Even a more conservative investment like a 3% CD at your local bank will bring about a much better return.
If Kevin had put his money into a CD over 40 years it would have returned $28,238. A difference of $13,638 – almost double the amount if he were to leave it under his mattress. Plug your own compound interest numbers in over at Money Chimp and see what your money could be doing for you.
These numbers are meant to get you paying attention your money as early as possible. The earlier you recognize how powerful compound interest can be, the quicker you can make a change and get your money working for you.
Make Money With Your Money
-Open an Online Savings Account. If you have any excessive amount of extra cash sitting in a checking account, move it to an online savings account at ING or another online bank. These banks pay a much higher interest rate and moving your money there is a major step in the right direction.
-Check out Certificate of Deposts (CDs) at online banks or your local bank. These tie up your money for a certain amount of time, but they usually have higher interest rates than savings accounts. As a bonus, CDs are a very safe way to keep your money.
-Start a Roth IRA and invest in low-cost index funds. These funds invest in the market average and aren’t effected as much by a CEO stealing money or a company’s poor third quarter profits. You can research these more at sites like Vanguard, Schwab, or Fidelity.
We could sit here and debate the best way to optimize your money, but the examples above are meant to be a nudge. A nudge to get you paying attention to your money and its earning’s potential.
What I learned from every paper in college is that the most difficult part of any project is getting started. The hardest work is done at the beginning and online savings accounts, CDs, and index funds are all low-maintence investment vehicles once they are set up. I talk more about the importance of getting your finances going in the right direction in the post, Get the Money Snowball Rolling.
Compounding interest involves giving up a little bit of control for your financial future. Let your money breath and it will come back even stronger in future years.
What about you? Why and when did you wise up to the magic of compounding interest?
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Hi, I'm Austin Morgan. I live in Japan, teach English, and write about personal finance. I hope you enjoy FF and feel free to 
That number in the graph is staggering. It is amazing how such a simple analysis can prove so much. I am about to move all of my non-interest checking account money into a savings or CD.
Another good account is Schwab. That is where I will probably move everything. They pay interest in your checking (it was up to 4.5% in 08Q1 and is now around 2-2.5%) and charge no fees for any transactions and will refund all ATM charges. Trust me. I used my Schwab debit card on ATMs in the back alleys of Laos & Nicaragua and wasn’t charged a penny.
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Austin Reply:
October 29th, 2009 at 8:34 am
Thanks for the comment, Casey. Hopefully some other people notice the numbers too and start to move their money in the right direction.
Which Schwab account are you referencing? I use their checking for the international ease but they only offer .75% and the savings account appears to be around 1%. Maybe I’m missing one, thanks in advance!
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You guys are funny and naive. Here are the actual rules of the road
The only way to get rich is work for yourself.
Bank and broker fees will take away any gains
Inflation will take away the rest
Best advice I ever had (and I paid for it)
Buy yourself 2 or more of the biggest freezers you can. Go out and buy gigantic amounts of groceries.
One year later you will have saved more money by doing that than any investment scheme will pay you.
I own my house, grown most of my food. I own a solar generator and a supermarket.
Good luck with that 40 year compound thing….
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Wow I feel bad for Bill.
My concern is that too many people think compound interest is easy. Unfortunately, it doesn’t just happen magically. There are a lot of of factors that come into play such as fees, inflation, taxes, etc. If people don’t manage these properly they will never be able to enjoy the real benefits of compound interest. Your talk about CDs and savings accounts might be ruined by taxes alone because most are fully taxed each and every year.
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Austin Reply:
February 8th, 2010 at 11:13 am
This is true, but for the beginner those shouldn’t be a concern. Once you get a grasp on your money and get it heading in the right direction, then you can worry about the specifics.
Thanks for the comment, CJ! I’ll have to check out your site some more.
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For a lot of recent high school and college grads they need to get this stuff tatooed to their forearm! Every year when you’re younger and not investing a couple grand could cost you hundreds of thousands down the road… Powerful stuff.
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Austin Reply:
February 16th, 2010 at 11:21 am
I hope my site’s popularity one day rivals that of bands where fans get my writing tattooed on their body.
(Adding that to my 2010 goal list)
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Ryan @ Planting Dollars Reply:
February 16th, 2010 at 11:26 am
Dream big man, you could get some cute nerdy Japanese groupies with pocket protectors and glasses… That could be your niche! Start throwing up images of your cute Japanese lady friends calculating their rate of return and I’m willing to bet you’d get a ton more traffic…
As a sidenote, what is your favorite band? Is there a lot of American music over there? Being in Hawaii I feel like I’m practically in Japan with so many Japanese tourists… Todo I don’t think we’re in Wisconsin anymore, haha.
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Austin Reply:
February 16th, 2010 at 11:29 am
That’s pure genius.
My favorite band of all-time is Blink-182. They are the springboard for everything I have ever listened to or liked. How about yourself?
There is a lot of American music. Bands are constantly touring, in fact, my lady and I are headed to Nagoya in a couple weeks to see a favorite band or ours, Motion City Soundtrack. Should be fun.
I think we’re going to Hawaii for Christmas this year. Where do you live and where do you suggest we go?
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Ryan @ Planting Dollars Reply:
February 16th, 2010 at 11:42 am
Big fan of Muse, listening to them right now:
http://www.youtube.com/watch?v=f_sHYn_cSn0&NR=1
I’m currently on Oahu near Waikiki, which is the main tourist drag and what I’m building a website about… feel free to follow along on my site where I’m documenting how I’m building the site.
http://www.plantingdollars.com/waikiki-travel-site/the-waikiki-travel-site-series/
It should be live in the upcoming months with advice around the area and more video.
I think it depends what you like to do the most. There are a ton of outdoor activities around here so the popular places are hiking Monoa falls (140-160 ft waterfall), going to Hanauma Bay which is a volcanic crater that’s now flooded and full of coral and fish, great snorkeling, and of course hiking diamond head. I actually just put a post up of me hiking diamond head if you’d like to check it out:
http://www.plantingdollars.com/my-journey/hiking-diamond-head-and-snorkeling-in-waikiki/
Shoot me an email when it gets closer and I can help you more if you’d like. That is, of course, if you’re coming to Oahu… don’t have much experience with the other islands… yet.
Ryan
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