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- I’ve heard the term compound interest for years, but never took the time to understand it. Once I finally did, I made three cash moves to take advantage of it.
- First, I opened a high yield savings account to earn more interest on my money.
- Then I put some money aside in an 18 month CD that is composing daily.
- Finally, I started making a monthly deposit to my retirement account – I had made one deposit per year and was running low on funding.
- See Business Insider’s Picks For The Best High Yield Savings Accounts »
Throughout my journey to fixing the financial mistakes I made in my twenties, I have heard people talk about something called compound interest. For years, I didn’t take the time to figure it out or learn more just because I was busy trying to clean up my financial mess and get on the right track. I spent a few years paying off debt, growing my savings account, putting money aside in an emergency fund, and slowly adding cash to my SEP IRA.
But the term
seemed to appear regularly in conversations with friends and financial experts. A few months ago, I asked my fiancé if he knew about compound interest. His answer said it all: “Yes, that’s how the rich get richer. “
A simple definition of the term is: Compound interest is the interest you earn on interest. Which means if you have $ 100 and it earns 5% interest each month, you will have $ 105 at the end of the first month and $ 110.25 at the end of the second. You not only earn interest on your initial deposit, but also on the interest you have accrued in the first month. What makes compound interest so powerful is that even if you never add another dollar to that initial deposit, the money in the account will grow exponentially over time.
My moment a-ha with compound interest
Finally intrigued to find out more, I spoke to financial planner Colin Exelby, the founder of Celestial Wealth Management, who not only explained what compound interest is, but how to get the most out of it.
“As you save and invest, whether it’s stocks, bonds, real estate or other investments, it often starts to grow. While this growth may or may not be guaranteed, this growth is in addition to what you are already saving and investing, “sys Exelby.” Then you can receive growth not only on what you have invested, but also on that growth. . “
I wondered how such an approach could transform a person’s money or, as my fiancé said, help a wealthy person get richer even more.
Exelby explained that with compound interest your savings can grow and accumulate and income can grow and accumulate to the point where income from growth is actually increasing at a faster rate than what you save.
“This is when your money really works for you and the power of compounding is unleashed,” says Exelby.
I decided to use this strategy to adjust three main areas of my life. Here’s how it transformed my money-saving plan.
I switched to a high yield savings account
To help me leverage my compound interest savings strategy, I decided to transfer my money from a savings account at a bank that only offered an interest rate of 0.03. % which is compounding monthly to a high yield savings account that was offering me 1.7% interest (although now it has plunged well below that) and is compounding daily. It was a game-changer in terms of extra money – I was making a lot more because of a higher interest rate and daily compounding, instead of monthly or even annually, and my money was growing faster .
I opened a CD that composes daily
I also decided to set aside a large amount of money that I knew I didn’t need in a high interest CD that was accumulating daily. I chose an 18 month term (so I could get a higher interest rate) and with daily compounding interest I was able to see the amount of money I put into the CD growing more quickly as if it was in my old savings account at a bank that wasn’t giving me much for my money.
I fund my retirement account monthly
Another big money mistake I made was not putting money into my retirement account except for one deposit per year. I figured I would save and then make a deposit into my SEP IRA at the end of the year. But my accountant told me to reconsider this strategy because the monthly contributions would earn more with compound interest than a one-time annual deposit (since I earn monthly interest on my SEP IRA and the interest earned is tax-deferred).