You’ve probably heard of compound interest and may even have a basic understanding of it. But why should you care about compound interest?
At the core, compound interest is really the math behind why it’s so important to start saving early. It’s the concept that powers all sorts of savings and investment products and allows you to turn your money into more money over time.
What will be worth more when you turn 65? (assuming a 7% interest rate)
- Starting at age 25, investing $5,000 a year for 10 years (total of $50,000 invested)
- Starting at age 35, investing $5,000 a year for 30 years (total of $150,000 invested)
Street Turtle explains the answer in the video below.
If you’re a visual person, you might also find this How to make the most of compound interest infographic helpful.
So if we understand that compound interest translates into free money down the road, what could possibly be standing in the way?
As it turns out, it’s not so much a math or finance issue as it is a life issue – we need to understand ourselves before we can fully understand our finances.
Acknowledge the big picture
A lot happens between your teens and your 30s – things like moving out, starting your career, dealing with student loans, getting married, financing a home. All these things have their own set of stresses that make it difficult to see past them into the future. When you’re a new grad and job hunting, it’s hard to imagine yourself retiring in 40 years. If you’re living with your family rent-free, it’s hard to imagine yourself putting down a deposit on a home. If you’re living paycheque to paycheque, it’s hard to imagine having enough to pay off your student loans.
The first step is to acknowledge that you want these things, even if they seem impossible right now. You want to retire comfortably. You want to buy a home. You want to live debt-free. You may even want to travel or go back to school. These goals may seem far away, but they’re definitely there and they’re certainly not going away. Every day that goes by is one day closer to the time when you want to achieve those goals.
The good news is that a little bit of your time and energy now can go a long way later. Make an appointment with your credit union or bank to learn about their savings products. Take 10 minutes and set up a recurring transfer into a savings account. When you’re dealing with compound interest, the longer you wait to get started, the less money you’ll earn in the long run.
Lack of clarity is self-sabotage
If you’re already at the stage where you can see the big picture, it’s time to get specific. You know you want to save for your retirement – great! But how much is that, exactly? $350,000? A million dollars? More? Do you have any idea?
These questions aren’t meant to overwhelm you, but if they caught you off guard, that means it’s time to add some real dollar amounts and real timelines to your big-picture goals. For example, you could turn “saving for home ownership” into “saving $50,000 in the next 12 years for a down payment on a home.” A good place to start is a retirement assessment tool.
Details make your goals more tangible, more immediate and, therefore, easier to commit to. Take a little time, do a little research and turn your big picture into something you can start on right now.
Don’t let decisions overwhelm you
Not many people enjoy making decisions – especially when it comes to life changes and major financial commitments. It’s easy to understand why – decision-making is scary (not so much the actual “deciding” part, but more the “fear-of-making-the-wrong-decision-and-regretting-everything-forever” part).
Savings goals require you to make a lot of big decisions. You need to choose goals to focus on, you need to choose between different banking products and you need to choose how to distribute your savings contributions. Sometimes the choices are brutally blunt, such as choosing between owning a car and paying off your credit card debt.
The important thing is to not let all that decision-making overwhelm you. Remember: just by facing those decisions, you’re making progress, because you’re establishing what’s most important to you and you’re renewing your commitment to your goals.