Earning interest on the money you save is a great way to grow your savings and prepare for the future. With simple interest, your money will grow slowly since you’ll earn money only on the principal. However, compound interest puts your money to work, allowing you to earn interest on the interest you earn.
At Addition Financial, we love working with our members to help them build financial security and pursue their goals. We reached out to some financial experts to get their best advice for investing with compound interest. Here are seven expert tips to help you grow your wealth.
#1: Be Realistic About Compound Growth
It’s true that compound interest will help your money grow more quickly than it would in a simple savings account, but that doesn’t mean compound interest is a get-rich-quick strategy. That brings us to our first tip, which comes from Jake Hill, the CEO of DebtHammer. This is what he told us about slow growth:
“Compound interest is a slow investment strategy. You can basically set it and forget it, depositing a little more on a monthly basis (or whenever you can) and letting it grow at a steady rate. To supplement this, use something like a mutual fund that will generate income more quickly but at a less reliable rate.”
We love this advice because it’s both practical and realistic. It’s important to have the right mindset about compound interest. Your money will grow slowly at first. However, if you get into the habit of depositing money regularly and leaving it to grow, you will see more rapid growth as time progresses.
#2: Use Compound Interest to Build Your Emergency Fund
Investing isn’t only about having money in your retirement savings. It can also be about securing your family’s finances, so that you have money set aside in case of an emergency. One of our financial experts, Ann Martin, is the Director of Operations at CreditDonkey. She said:
“Savings accounts with high compound interest rates are perfect for setting up an emergency fund.”
Having an emergency fund is a must. If the COVID-19 crisis taught us anything, it’s that things like employment and earning ability can change quickly due to circumstances beyond our control. We recommend having a minimum of six months’ worth of expenses saved to ensure you can make your mortgage or rent payments, pay utility bills and buy groceries, gas and other essentials. We suggest a money market account for your emergency fund because you’ll earn compound interest at no risk.
#3: Don’t Wait to Take Advantage of Compound Interest
There’s no real benefit to waiting to take advantage of compound interest with your savings and investments. Because compound interest is a slow-and-steady growth strategy, time is your friend. Chris Morgan, a Credit Expert with Credit Help Info, told us this:
“In my opinion, in whatever method you choose to invest, the most essential step is to create at least one account and begin contributing regularly to it so that compound interest may work in your favor. You'll be better off if you start sooner rather than later.”
We’ve sometimes had members tell us that they’re waiting to save or invest. Our advice is always to start now. Even if you only have a small amount to save, you have nothing to lose by earning interest on it starting immediately. You may need to start small, but as your savings grow you’ll be able to take advantage of other investment options that you couldn’t afford if you hadn’t saved money.
#4: Use Compound Interest to Pursue Riskier Investment Strategies
You already know that compound interest is money that is earned by money you already have – in other words, it’s your money going to work for you. Because it’s not part of your principal, you may want to consider taking the money you earn in compound interest and using it to fund other investments.
Carter Seuthe is the CEO of Credit Summit. He gave us this advice:
“One thing I like to do is keep track of the total interest generated. I then withdraw that and invest it in a riskier option like stocks. This allows me to experiment without feeling like I'm taking on as much risk.”
We love this advice. It can be undeniably intimidating to dip a toe into the world of investing if you haven’t done it before. However, investing is – for most people – the best way to save enough money to pay for your expenses in retirement. Using the money from accumulated interest to experiment with different investment types and strategies is a great way to get accustomed to investing without taking on too much risk.
#5: Put Your Money in a Certificate of Deposit
There are multiple types of accounts that offer compounding interest to investors. One low-risk option is to put your money into a Certificate of Deposit, also known as a CD.
CDs offer compounding interest that can vary from account to account. As you might expect, interest rates fluctuate. However, with a CD, your interest rate gets higher as you increase the term of the CD. You will get a lower interest rate for a 12-month CD than you would for a five-year CD.
If you do decide to buy a CD, you will pay the principal and the money will be inaccessible to you for the term you have chosen. The interest will compound regularly; it’s common for CDs to compound interest monthly, but some may compound daily.
If you choose not to renew the CD, you will receive your principal amount plus the accumulated interest you have earned during the term. If you do renew, then you can roll the interest over into a new CD and earn even more interest on it.
#6: Use the Buy and Hold Strategy
Investing with compound interest is only a good strategy if you’re prepared to hold steady when the market fluctuates. In other words, you must have both patience and decent risk tolerance.
People who do well with compound interest are those who leave their money alone and allow it to grow. If you constantly move your money around or withdraw it when the stock market declines, you won’t get the benefit of compound growth in the same way you would if you left it alone.
It may be helpful to know that the overall, long-term trend of the stock market is up. It’s also important to remember that the Dow Jones Industrial Average (DJIA) and NASDAQ are only two of many indices in the market. They do not represent the market as a whole – they just get the lion’s share of the attention.
#7 Split Your Money Between Saving and Investing
A lot of people make the mistake of assuming that if they set aside money each month to save that it’s essentially the same as investing it – and thanks to compound interest, that’s simply not true. Your money will grow far more quickly if you take advantage of higher earnings on investments.
To illustrate the point, let’s look at an example from financial expert Suze Orman. She pointed out the vast difference between putting $100 per month into a traditional savings account and taking that same $100 and putting it to work in an investment fund.
According to Suze, if you started with a $5,000 initial investment and put it in a savings account with simple interest, continuing to contribute just $100 per month, you would have only $65,000 by retirement age. By contrast, putting the $5,000 into a diversified portfolio with a 6% annual return and investing an additional $100 per month would yield approximately $452,000 in 50 years.
It’s important to note that Suze’s advice also includes the “buy and hold” strategy we mentioned above. You should review your investment mix regularly and make sure that you’re adjusting your investments to spread out your risk. However, panicking and selling because of a dip in the market will not serve you well in the long term.
None of this means you shouldn’t save money. As we noted above, putting your emergency fund into a money market account will allow you to take advantage of compound interest in a small way while still ensuring you have the liquidity you need. You can start by splitting your monthly savings between a money market account and an investment account, and then once your emergency fund is set, put your savings into a mix of investments with a decent yield.
The most important takeaway regarding compound interest is that it’s a long game. You shouldn’t go into it expecting your money to grow quickly. It’s essential to be patient and understand that compound interest will benefit you only if you leave your money to grow. It’s also a must to start investing as soon as possible. Investing at an early age will allow you to accumulate far more wealth than you would if you waited.
Are you eager to harness the power of compound interest? Click here to book an appointment with one of our Financial Professionals today!
Posted on Aug 21, 2021
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