How compound interest can change your life–really!
Nobel Prize winner and renowned physicist Albert Einstein is rumored to have called compound interest the eighth wonder of the world. Regardless of whether he said it or not, it might actually be true, at least in the mathematical world. Compound interest is a powerful income-generating, wealth-building tool that can substantially impact your financial future.
If you don’t know what compounding interest is, or better yet, how it works, don’t worry—you’re in good company. According to ValuePenguin, who asked 2,000 Americans if they could accurately define some financial terms like net worth, credit score, and compound interest, nearly 70 percent of Americans had to ask Siri for help. Let’s see if we can fix that.
Simple vs. compound interest
There are two different types of interest: simple and compound. Simple interest is interest earned on only the principal amount of your investment. Consider a certificate of deposit (CD), for example. At the end of the term, you’ll receive your initial investment amount plus a fixed amount of interest.
Compound interest, on the other hand, is interest earned on interest, and it’s the quickest way to bump up your balance. Each period’s interest (daily, monthly, quarterly, or annually) is earned on the initial amount of your investment plus all the previously accumulated interest.
Here’s an example:
If you invest $10,000 at 7% simple interest, $700 in interest will be added to your account after Year 1. In Year 2, another $700 in interest will be paid to your account… and again in Year 3, Year 4, and so on. As long as the interest rate remains the same, you can count on earning the same $700 amount year after year.
If your $10,000 investment paid 7% compound interest, you’d see the same $700 interest in your account after the first year. However, in Year 2, your interest will be calculated on the new balance of $10,700, not your original investment of $10,000. The interest payment for Year 2 will be $749, which is then added to the $10,700 in order to calculate the interest for Year 3, and so on.
The effect of compound interest is extraordinary. At 7% simple interest, your $10,000 investment would be worth $27,500 after 25 years. With compound interest, the value would have grown to more than $50,000. It’s easy to see which one puts your money to work, and makes the biggest difference.
Invest sooner than later
You don’t need to be a mathematical whiz to benefit from compounding interest.
When you’re saving or investing money, compound interest will continually give you a financial boost. The more time your investment has to run the cycle of earning interest, adding it to the investment balance, and then earning interest on the new balance, the better. Want to see how much a specific investment amount could grow with compound interest? Check out this compound interest calculator.
Put your money to work
Compound interest works the same way, regardless of the amount of money you invest, and it adds up faster than you think. At 6 percent compound interest, your money should double in about 12 years and be worth four times as much in 24 years–that’s the Rule of 72. Simply take the interest rate and divide it into the number 72, which will estimate the number of years it will take for your money to double in any one investment.
Compounding interest can be an important component of your overall financial strategy. It’s ideal for investors with longer time horizons, but it also works for investors who’ve gotten a late start saving for their future. Whatever your situation, don’t wait another day. Put your money to work now and take advantage of the power of compounding.
Four things to think about if you’re ready to start investing
Saving and investing are two of the best ways to build wealth. For many people, though, the leap from saving to investing is a big one. In fact, a recent survey commissioned by Ally Financial reported that 70% of Americans age 18 to 39 know they need to become more financially secure, but don’t know how to go about getting there.
If you’re saving, you’ve already taken the first and most important step. But, we know that investing can be intimidating, especially if you don’t know where to start. Keep in mind that accumulating wealth is a gradual process and not something that happens overnight.
It can be, however, virtually painless and help create additional funds for retirement, recreation, education, or whatever other investment goals you have. It can help you start a business, send your kids to college, buy a beach house, travel around the world, or spend more quality time with your grandchildren.
Need more concrete encouragement? $1,000 invested at the stock market’s historical return rate for 20 years would grow to almost $6,000. Apply that to 30 years, and it would leap to $15,000. Now, with every investment, you assume some level of risk, and past performance doesn’t guarantee future performance, but you can see the possibilities.
If you’re ready to start investing, here are some steps that will help you identify the most appropriate products and investments to help you reach your financial goals.
Determine your investment goal
What financial goals do you want to achieve by investing? It may be to simply start accumulating wealth, or you may have a specific goal in mind. It could be to buy a home, pay for a wedding, go on a vacation, or fund your child’s education. Goal-based investing is a process that helps ensure that you have enough money when you plan to spend it in the future. It impacts the type of investments you might choose and whether their strategy is growth, income or stability focused.
Determine your investment budget
Regular and systematic investing is the easiest way to invest your hard earned dollars. That means that a percentage of your income is automatically invested into an account every month. It effectively allows you to leverage the long-term benefits of dollar-cost averaging (DCA) and helps to better manage short-term investment volatility.
Creating a monthly budget and earmarking funds for investment helps separate them from your spending dollars. When you “pay yourself first” by treating your investment account as an expense, you’re more likely to make smarter financial decisions with your remaining monthly funds. And, it helps ensure you stay on track with your investment plan.
Determine your risk tolerance
Every investment comes with some level of risk and generally, the more risk, the greater the potential return. It’s pretty safe to say that most people want to make money as quickly as possible, but if your risk tolerance isn’t up for the challenge, the anxiety it brings will never be worth the chance of realizing the reward.
Be honest about the amount of risk you’re comfortable assuming. Most investment plans are designed for long-term growth. If you’re checking your account balance on a daily basis and you’re riding a rollercoaster of emotional highs and lows as a result, your investments are not in line with your risk tolerance. Investing doesn’t have to be scary. There are options for every type of investor.
Determine your time horizon
Your time horizon is the amount of time you have until you need to withdraw your funds. With a long time horizon, you can afford the privilege of slow and steady gains that limit your risk. For example, if you begin saving for retirement at age 20, you have 45 years to weather the ups and downs of the market. If you begin at age 35, you’ve lost 15 years of compounding growth and need to earn more money in less time, which, to accumulate the same amount, might entail more risk. If you begin saving for your child’s college education when they’re born, you have a lot more time than starting when they turn 10. To offset a short time horizon, you can consider increasing your investment dollar amount or possibly assuming more risk for the chance of a higher potential reward.
Most investors begin with a company-sponsored retirement plan or an IRA. There are typically a limited number of investment options and the plans generally lean toward conservative investing, although there are exceptions.
If you’re new to investing, don’t rule out the help of a financial advisor. You don’t have to be a financial guru, especially when you’re smart enough to leverage the expertise around you. They can help you sort through some of the ideas above and work with you to establish a solid financial plan for your future.
What is a financial advisor and do I really need one?
Some think that only wealthy people need financial advisors. Whether it’s a financial planner, wealth manager, money manager, retirement planner, or a slew of other similar titles, they generally all mean the same thing: financial guidance for people who want a strategy to achieve some future monetary goal.
Planning for life events
Eventually, we all experience some big life event, whether it’s paying for college, or buying a home, starting your own business, or caring for aging parents. Often times, your financial goals can overlap, collide, or simply seem unmanageable. A financial advisor will not only help you navigate the journey, but they’ll also work with you to prioritize your efforts. Sometimes you just need a more structured savings and investment strategy that can lead you to a more comfortable and less overwhelmed mindset.
Maximizing your current assets
Sometimes the help of a financial advisor is about managing the funds you already have. Many people use an advisor’s expertise to invest their savings and maximize the opportunity to put their money to work. They can help manage an investor’s tax liability, too. A financial advisor that specializes in tax-deferred investment vehicles can help you determine the most advantageous time to take a distribution from your retirement plan or identify beneficial tax-sheltered options.
Regardless of intellect, an investor may lack the appropriate knowledge when it comes to choosing investment options. Trying to balance the relationship between risk and return with your time horizon and your financial goals can be tricky. A smart investor seeks out and leverages the guidance of experts, even if they have investment experience. Don’t ever underestimate the value of professional advice.
Getting back on financial track
For some, their finances are one step away from crashing and burning. If you’re struggling with debt, a consolidation plan might be a wise first step. Financial advisors can develop a plan–not a get rich quick fix–where you’ll learn discipline, recognize your spending habits, and be held accountable so you can move toward improved financial health.
When you work through your goals with an advisor that has in-depth knowledge of your financial situation, you’re able to create realistic expectations and learn to plan accordingly. Recommending appropriate investment vehicles and a savings strategy can help guide you through the uncertainty.
While some advisors require a long-term arrangement, there are many who offer free consultations and no-obligation appointments to review your financial plan–or lack thereof. Check out the services offered by your local bank or credit union and set up a meeting. If they don’t give you a gold star and a pat on the back, they’ll be sure to recommend a realistic strategy. Either way, you win!
Investing 101: What is a CD and are they right for you?
Why do people invest their money? It’s likely because they’re saving for something—a trip, a home, a child’s college education—or simply because they don’t want to work until they’re 108. People earn money by working, but putting your money to work is also an excellent way to build wealth and help you afford the things you want in life.
Investing is the most effective way to grow your money over the long term, but risking what you already have for the prospect of something more in the future can be a scary thought. Couple that with the complexities of the financial markets and it’s easier just to stuff some cash under your mattress.
The truth is, investing doesn’t have to be complicated. In fact, there are some conservative options that can help you earn extra cash without pushing you beyond your comfort zone. Both seasoned and novice investors can benefit from the safer, simple choices, like a CD, for instance.
What is a CD and how does it work?
A certificate of deposit (CD) is a promissory note that’s issued by a bank or credit union. It comes with a future maturity date and a fixed interest rate. When you invest in a CD, you, as the investor, agree to loan your money to the issuing institution for a specific period of time and a predetermined rate of return.
When you purchase a CD, you give up access to your funds until the maturity date. For forfeiting your liquidity, you earn compensation in the form of interest. Once the CD matures, the bank refunds your initial investment, which is called the principle, plus your earned interest.
CDs are issued for different terms. Long-term CDs typically offer a higher rate of return compared to short-term CDs. Why? Because your restricted access to the funds is for a longer timeframe and the longer you’re required to hold your investment, the higher level of risk and uncertainty you assume.
How risky are CDs?
On the spectrum of risk and return, CDs are considered conservative investments. Federally-insured bank CDs are backed by the Federal Deposit Insurance Company (FDIC), and Credit Union issued CDs are guaranteed by the National Credit Union Administration (NCUA). Even if the issuing institution collapses, your investments are protected.
The risk that you assume with CDs is interest rate risk. When you invest in a CD, you agree to a specified rate of return. As the financial markets fluctuate in response to economic and political factors, you want your CD’s rate of return to remain competitive. If CD rates rise, your current investments could be locked into a lower rate for an extended period of time. While you don’t run the risk of losing your investment and your earned interest, but you could miss out on the opportunity to earn more money than with your current CD.
One way to reduce that level of risk is called laddering. You can stagger maturity dates among several CDs so that matured deposits can be reinvested at potentially higher rates and you’re able to gain periodic access to cash, if necessary.
Explore your options
As with any investment, be sure to familiarize yourself with the fine print. A common concern with CDs is penalties for early withdrawal. If you experience a hardship and have to cash in your CD, it could significantly affect your earned interest or even your principle. Today, there are specialty CDs like penalty-free CDs, Bump Up or Raise Your Rate CDs, IRA and Jumbo CDs. If you’re considering an investment, be sure to speak with your financial advisor to determine which options will meet your individual needs, both in the short and long term.
Information about Meltdown and Spectre
You may have heard news reports about Meltdown and Spectre, two computer bugs affecting electronic devices. We want to assure you that the security of our members’ information is our top priority and we have, and will continue to protect it from viruses such as these.
We have a robust Information Security Program to keep our members’ information safe and we have been working closely with our vendors to address these bugs specifically. For more information about Meltdown and Spectre, please click here.
15 ideas for how to get out of credit card debt
When it comes to money, there are few things more gut-wrenching than seeing those credit card statements pile up in your inbox every month. You hesitate to open them because you already know that they’ll be worse than last month. High interest, late fees, impulse purchases…it’s out of control and you need a game plan.
According to Investmentzen.com, the average American household has $16,748 in debt. And with an average interest rate of more than 15%, that’s no small chunk of change. Compounded with the worry and stress of managing that burden, the number of consumers looking for realistic ways to pay down their debt grows every day.
We came up with 15 easy but effective ways to help you dig yourself out of debt as quickly as possible:
- Create a spreadsheet. Be sure that it details all of your debt so you can see the full picture. You’ll know where you started, be able to track your progress, and know when to celebrate the milestones.
- Toss offers for new credit accounts. The more credit you have available, the greater the opportunity you have to build up a balance. It’s too much of a temptation!
- Stop making purchases with credit. Pay cash whenever possible. It will take some sacrifice at times, but you’ll be sure to spend less and only buy what you need.
- Negotiate a lower interest rate. If you’ve been a long-time customer with an on-time payment history and a worthy credit rating, your current creditors may be willing to lower your rate to keep your business.
- Track your spending. Some consumers honestly don’t know where their money goes. Write down every dime you spend for one month, and you’ll soon find out where your money goes when it disappears.
- Create a realistic budget. Start with the necessities. It’ll help you identify those areas where you can lower your expenses—like cable subscriptions, gym memberships or cleaning services—so you can redirect it to paying down your debt.
- Find ways to earn extra cash. Would a part-time job fit into your schedule? How about consigning some clothes on Poshmark.com or Swap.com? Ever wanted to be a mystery shopper? House sit, babysit?
- Curb your social media interaction. Keeping up with the Joneses takes a lot of hard work. New clothes, new golf clubs, a fancy family vacation…they all cost money. Don’t let them tempt you.
- Start cooking at home. It’s a lot easier–and tastier–to eat out, but it also costs more. It’s time to channel your inner Rachael Ray and get cookin’. That includes lunch, too.
- Send extra cash to your highest-interest credit card. Just don’t forget about making the minimum payments on your other credit cards to keep them current.
- Consider a balance transfer. If your credit card has a high interest rate, you may be able to find one with a 0% promo rate. Be careful though– read all the fine print about transfer fees and interest rates after the promotional rate expires.
- Consolidate your debt. A debt consolidation loan from a bank or a credit union may help you pay off your credit cards all at once. Then focus on making one large monthly payment to repay the debt consolidation loan.
- Track your progress. It’s hard not to obsess over your progress. Set reminders every few months to measure your success and find a fun, inexpensive way to celebrate!
- Keep your goals front and center. Will paying down your debt help you buy a home? Finally get a good night’s sleep? Pay for your daughter’s wedding? Whatever it is, it’ll keep you motivated when you slip up, or things aren’t moving as quickly as you’d like.
- Talk to a credit counselor. If your debt is too overwhelming, there are highly reputable, non-profit consumer credit counseling organizations that are experts in this area. Their services are free of charge. They’ll help you create a budget, review suitable options for dealing with your debt and design an action plan specifically for your situation.
Once you’ve reached your goal, it’s important to guard against the bad habits that helped you get here in the first place. Following a budget and using credit responsibly will help you maintain healthy financial habits. With that comes less stress and greater peace of mind, and who doesn’t want that?