The Power of Compound Interest

 By Rob Wrubel, CFP^®

“I like dreams of the future better than the history of the past.”

 - Thomas Jefferson 

Albert Einstein is attributed with saying that there is no greater force in nature than the power of compound interest. Are you letting the power of compound interest work for you? Or against you?

Compound interest is the ability of money to make money over time.

How does this work? Imagine you have $1,000 dollars to invest. You take it, and find an investment that gives you a 10% rate of return over time.

The next year, your investment is worth $1,100. That is your original $1,000, plus the 10% rate of return, or 100 additional dollars.
The next year, you earn an additional 10% on your $1,100. You now will have $1,210. That is 210 additional dollars on your original investment. If you continue to earn 10% each year, you will double your money in roughly 7 years.

Your money earns money while you watch. Not bad. You don’t have to pick up a shovel, type a report or teach a class. Your money has the power to earn money on its own.

Why does this matter to you as you think about financial planning and saving for your retirement, your special needs family member and other goals you have in your life?

It means that you want to take action today.
So often, I meet families who put off their planning, saving and investing. They put off paying down debts, starting emergency funds and planning.

They also put off the chance for their money to earn for them over time.
Over the past month, I have met with several people who have family members with special needs. They all understand and know the need to move forward with planning. But why haven’t they done anything yet? Are you in the same boat?

There are many reasons not to start. All of us wish we had more time and starting a new activity means time away from something else. You have immediate expenses and bills to pay today and find it hard to find additional savings. You have accumulated significant assets but are fearful of losing them by making bad choices. You have family stories telling you not to think about money. You somehow never learned how to handle money the right way.

You need to replace those reasons for not doing anything with better reasons for making financial well-being important. You need to develop a funding plan for your family and for the needs of your special needs loved one.

The reasons for action are many and the outcomes important.Securing a comfortable retirement.
-Providing an education for children.
-Having enough money to provide an exceptional quality of life for the disabled family member.
-Buying a house that meets your family’s needs.
-Traveling the world to fulfill your life’s dream. 
-Going back to school to pursue an advanced degree.
-Saving enough to start a business.

You will find it helpful to write down your important reasons for accomplishing goals. For example, you might write, “I save money today to insure a comfortable and joyful retirement.” You might write down, “I wish to provide for my daughter with Down syndrome so that she can have access to travel, education, entertainment and transportation as she will not likely be able to provide those for herself.”

Make these statements personal and meaningful to you. Write them today how you feel about it today, even though those thoughts and dreams may change over time. Write them as often as you can to keep them alive and present in your daily life. Some people put these on flashcards and keep them on their work desk. Others write statements to carry in their wallets.

What does this have to do with the power of compound interest?
Compound interest takes time. Most people can create significant assets over time by paying off debts and investing. While one or two years of interest is nice, the multiplier effect really kicks in over years and decades.

Remember the example of taking $1,000 from earlier. In seven years, it becomes close to $2,000. In 25 years, that same $1,000 saved becomes close to $11,000. If you add to that every year—maybe through an IRA or 401k—your $1,000 per year of savings becomes more than $108,000 in 25 years.

The power of compound interest works against you when you have debt. People who carry balances owe more each month to the credit card company as those underpaid interest amounts get added to the balance.

You may have a goal of funding a special needs trust to pass an inheritance to your special needs family member.  I work with many people who have already accumulated significant assets. These people look to put transfer plans in place to make sure those assets get into the trust.

Most people need to work on savings and accumulating. If you are in that group, you increase your chances of having enough to pass along by starting as quickly as possible.

Investment examples are illustrations and not any specific investment. The point is, whether your are investing in the stock market, real estate or your own business, you want to give yourself enough time to have your money make money.
Take out your to-do list (the side bar of this column will work fine). Write in big letters—START FINANCIAL PLAN. Underneath that, write down a date you will sit down with your spouse, partner, a friend or professional. Review daily.

As always, feel free to give me a call. I work with families with a special needs member, their professional advisors and the organizations that support them.