What is Compound Interest?

What is Compound Interest?  And how does it work?  It may impact your family.  Also covered, the cost of procrastination and why banks tend to have the nicest buildings downtown.  No illustrations or investments were hurt during the recording of this episode.

Welcome, Sean Williams from Sojourn Wealth Advisory.  I’m at the Towson Farmer’s Market today and this is episode 12. 

And we’re back.

The next couple of episodes I’m going to share some key financial concepts—concepts that I believe you’ll be interested to learn that can have an impact for you and your family.  The first one being compound interest.  So what is Compound Interest and how does it work?

For illustration (and for dinner tonight) I bought some corn.  Now this corn was harvested to be consumed, but if it had been harvested later for seed and we had taken that seed and planted it we would have had even more corn the following year.  And if the following from that harvest we had planted even more corn we would have had an exponential growth.  We would have had growth on top of growth, which would be compounded. 

So how does that work with money? 

For illustrative purposes, let’s say a person is 25 years old and they invest $5,500 each year for 40 years until their age 65.  And let’s assume they have an 8% return.  So since we’re making an assumption we have to share a disclosure. 

This is for illustrative purposes only and is not a guarantee or indicative of any investment’s potential performance.  All investments can lose money.  No investment has earned the same amount of return each and every year.  That would be ridiculous.  No illustrations or investments were hurt during the recording of this episode. 

Okay so we’re going to assume 8%.  Now if that person had invested $5,500 each and every year and received that 8% return by the time that they were 65 they would have $1,424,810.85. 

Now, let’s look at another example.  Let’s assume we have another person who is age 35 and they begin investing $5,500 each and every year until they turn 65.  So they have invested for 30 years.  By the time they turn 65 with that same 8% return assumption, they would $623,057.66.

That’s a difference of 10 years of investing and $55,000.00 of investments.  Right? Because the first person had invested $5,500 more each and every year for 10 years.  So $5,500, $55,000.  But when they both reach age 65 there will be a difference between the two of them of $801,753.19.  The first person has more than double of what the second person has. 

That is the cost of procrastination.  In this example the cost of procrastination is $801,753.19.   

If you were to graph compound interest it might look something like that.  Not to scale.  But the second person because they had delayed it didn’t start here, they started here.  And so that curve looked something like that.  But they didn’t receive the benefit of the curve on the right side (my left, your right)-the curve on the right side as much and so their return wasn’t as much as it could have been had they started earlier.

Now you might be thinking, these scenarios don’t really apply to you, but compound interest does and the longer you procrastinate the more compound interest can’t work for you.  Said differently, the earlier you begin the sooner compound interest may be able to benefit you. 

In your situation, you might be able to save more than $5,500/yr. or $460/mo.  And it may not be about age 65.  It may be about creating an inheritance for your family, such as your kids, grandkids, or even your great-grandkids.

Now before we go, here’s another lesson: Compound interest may be working for you or it could be working against you.  It might not be about what you’re earning, it could be about what you’re owing. 

When it comes to debt like mortgages, home equity lines of credit, personal lines of credit, car loans, student loans, credit cards with balances… all of these charge interest and it may not be about what it’s costing you today, but also the money that it’s costing you into the future.  In these examples it’s the banks that are earning compound interest off of you.  And now you know why banks tend to have the nicest buildings downtown.

Compound interest has momentum but it takes time to work and that momentum can either work for you or against you. 

Thanks for watching.  If you enjoyed the episode be sure to let me know.  Comment, share, subscribe, follow.  Comment below with what you thought was most helpful in this episode. 

If you’d like to schedule a private conversation head over to sojournwealth.com and reach out to me. 

Until next time, sojourn well.

​