Compounding Interest

Compounding Interest: The Time is Now

In our first post on investing, we laid out some very simple, but extremely important, investing principles.  We introduced the concept of inflation and why money that sits in your bank account usually loses value over time. To truly grow your money and reach your goals, you need to invest. And thanks to the magic of compounding interest over time, the earlier you start investing, the less total money you have to save.

That’s right! Being on time matters – not just to your fiancé/spouse, but also for your investment and wealth-building plan.

Compounding Interest: The Sibling Competition

To hit this point home, we’ll use the age-old, over-simplified example of a sister (Emily) and brother (John). Emily gets organized earlier on in life and invests $3,000 a year from age 18 to 27. Her brother, John, starts saving $3,000 per year from age 28 to 65.

Over their lifetime, Emily invests a total of $30,000 and John invests $84,000 more of his hard-earned dollars for a total of $114,000. Let’s assume they each earn 10%, which is the historical long-term rate earned by investing in large company stocks.

Enough with the details! Who ends up with more when they both retire at 65?

It’s not even close! Emily ends up with over $765,000 more! That means more money to buy that dream home, buy that boat, or take that nice trip to Thailand with her (lucky) husband.

What to do Before Investing

Now you’re probably itching to start investing as soon as possible. Investing can be a lot of fun as you watch your net worth continue to exponentially grow and you’re able to reach those goals. However, before beginning, it’s important to mention that you should take care of other financial matters first.

Here’s a few priorities, which we’ll cover in more detail in other posts:

1.       Initial emergency fund: Save one month of non-discretionary expenses in a safe place. This means things you have to pay for (think rent), and not optional things like that concert or Lulu outfit. For most young couples, one month is $1,000 to $3,000.

2.       High-interest rate debt: When you invest in stocks, bonds, etc. you’re hoping to receive a certain return on your investment. It’s not guaranteed. However, when you pay down your debt with high interest rates, you’re ensuring you earn/save at that high rate. Tackle this as fast as possible.

3.       Contribute to retirement plans (401(k)s, IRAs): If your employer offers a 401(k) match, make sure you’re at least contributing up to your employer’s matching percentage – it’s free money! For many companies, this means contributing 6% of your gross pay. If your employer doesn’t offer a 401(k) plan or match, try to max out your contribution to an IRA or Roth IRA ($5,500 per year at the time of this post).

4.       Remaining emergency fund: The ultimate goal is to have at least three months of non-discretionary expenses in your emergency fund. You’ve already taken care of one month. Now prioritize saving for two more.

Now Start Investing and Earning Compounding Interest

Phew! That was a lot! Taking care of those priorities means way less stress and worry with your finances, and a much lower chance of taking out these emotions on your partner. Agreeing to a plan, tackling each goal together as a team, and seeing real progress can have amazing benefits for your relationship.

Checking those items off the to-do list also means you can start venturing into investing. Keep an eye out for future posts on strategies and tips that can help you both successfully invest together.

Questions

What stage are you in with your finances? Are you investing yet or still working on some of the earlier priorities? Comment below and let us know!

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3 comments

  1. Morgan says:

    Hi there!

    I have checked off most of the boxes in the above (I am still paying off my school debt). I was wondering if you have any articles or tips on how to start investing? Starting from square one and at elementary school level…. I am 26 haha but find this to be very confusing! I am single and living in NYC.

    Thanks!

    • Financially Engaged says:

      Hi Morgan!

      Thanks for the comment! That’s totally fine that you’re starting from square one and it’s super common! It’s great to hear that you’ve taken care of the earliest priorities. We also love getting feedback on what our readers want to learn more about. So far, we’ve started with some of the fundamentals for investing, but we plan to add some more posts soon that discuss some of the different investing options and strategies. Keep an eye out for our future posts!

  2. Dani Schultz says:

    It is so crazy to see how compound interest is a game-changer when investing. Also unreal to see how compound interest can effect debt in the opposite way. Thank you for putting this post together.

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