By Lee Sherbakoff, CPA/PFS, CFP®, RICP®
Do you want to know the two most powerful words in the financial world? Compound interest. It’s not some flashy investment scheme or hidden secret only a few people know, but compound interest has changed how people build wealth and has actually made wealth-building more accessible for millions. The beauty of compound interest is that it’s a simple but mighty concept that takes your initial investment seed and grows it into what will eventually become your nest egg. Here’s how it works and how you can harness its power in your own financial life.
How Compound Interest Works
Simply put, compound interest means you earn interest not only on a principal amount but also on the interest you receive. For example, if you invest $100 and earn 10% interest annually, you will then earn interest on $110 during the next compounding period without additional contributions. Then you would earn interest on those earnings, and the cycle would continue.
This compounding effect allows wealth to grow exponentially rather than linearly. There are multiple factors that influence the amount an investment will grow through compound interest, including:
- The interest rate earned on your investment
- The frequency of compounding
- The amount of time your money has to grow
Naturally, the higher rate of interest, the more your money will grow. But higher interest rates are often accompanied by higher risk. Additionally, higher frequencies of compounding will result in greater growth. And because compound interest growth is exponential, the amount of time an investment has to grow is perhaps the most important factor when it comes to wealth-building.
The Time Value of Money
The time value of money concept states that money you have now is worth more than the same amount of money in the future. This is because money has the power to earn interest, so the earlier you start investing that money, the more time it has to grow exponentially.
Consider the example from above: If you receive $100 today and invest it at a 10% interest rate compounded annually, you would have $110 a year from now. Therefore, that $100 is worth more to you today due to its earning potential over time.
The Miracle of Compound Interest
To truly understand the awesome power of compound interest, suppose you are able to save $2,000 a month. If you saved $2,000 a month for 30 years in a non-interest bearing account, you would have $720,000 at the end of the savings period.
But if you invested $2,000 a month into a tax-deferred retirement account that earned 10% then your monthly compound interest would look like this for the first year:
By the 30-year mark, you would have $3,982,755.35. You can view the growth in the chart below: (1)
Conversely, if you invested $2,000 a month for just 15 years at the same annual rate of 10%, you would only have $770,894.06 (per the graphic below). (2) That’s a difference of more than $3,000,000. Without a doubt, the longer amount of time you’re able to invest, the more drastically your wealth can grow.
This is why you shouldn’t wait another day to start saving in compound interest investments.
Start Harnessing the Benefits of Compound Interest Today!
Taking advantage of compound interest should be an integral part of your financial and retirement plans. If you need help understanding and capitalizing on compound interest opportunities, our team at The Nalls Sherbakoff Group would love to partner with you. Set up a complimentary appointment so we can see if our services are the right fit for you by calling us at (865) 691-0898 or contacting us online.
Lee Sherbakoff is principal and financial advisor with The Nalls Sherbakoff Group, LLC, an independent, fee-only financial planning and investment management firm. He specializes in serving pre-retirees and retirees, helping them create and execute financial plans and retirement income plans that lead to sustainable long-term, real-life returns that meet their deepest and most important financial goals and objectives. Lee has a Bachelor of Science in Finance from The University of Tennessee and a Master of Strategic Studies from the U.S. Army War College as well as the Certified Public Accountant (CPA), Personal Financial Specialist (PFS), Certified Financial Planner™ (CFP®), and Retirement Income Certified Professional (RICP®) credentials. Lee spent over 31 years in the U.S. Army Reserves, including serving at the Army’s highest levels on the Department of Army staff at the Pentagon and being deployed in support of Operation Desert Storm (1991) and Operation Iraqi Freedom (2008-2009). When he’s not loyally serving his clients, Lee enjoys giving back to the community and to his profession, acting as a council member of the Tennessee Society of CPAs and a member of the American Institute of CPAs. In addition, he is past President of the Knoxville Chapter of Tennessee Society of CPAs and past President of the East Tennessee chapter of the Financial Planning Association. To learn more about Lee, connect with him on LinkedIn.
DISCLOSURES: The information provided is for general informational purposes only and should not be considered an individualized recommendation of any particular security, strategy or investment product, and should not be construed as investment, legal, or tax advice. The Nalls Sherbakoff Group, LLC makes no warranties with regard to the information or results obtained by third parties and its use and disclaim any liability arising out of, or reliance on the information. These indexes reflect investments for a limited period of time and do not reflect performance in different economic or market cycles and are not intended to reflect the actual outcomes of any client of The Nalls Sherbakoff Group, LLC. Past performance does not guarantee future results.