Meet Your New Friends

Women in finance: understanding compounding interestFriday: Money in Your 20s, 30s, 40s, 50s, and Retirement
I’d like to introduce you to your new friends: Early, Often, and Compounding InterestEarly and Often are twins who go hand-in-hand because they enjoy spending time together.  The sooner you meet these two and make them your friends, the better off you’ll be.  Save Early, as in start today, and do it Often, as in regularly.  Saving in your 20s (even in small amounts) helps you much more than starting to save in your 30s and 40s, even if then you’re saving larger amounts.

Once you’ve befriended Early and Often, they’ll want you to add their best friend: Compounding Interest.  Why do Early and Often like Compounding Interest so much?  Because she’s extra special and she’s where the real magic of this friendship happens.

What’s the magic behind Compounding Interest?  Compounding Interest is what allows your money to make more money.  Compounding Interest is the increase in your money from the return it earns on itself.

Compounding Interest seems simple but for some reason our minds have a hard time understanding how powerful this concept is.  It’s not just the actual money you put into an investment, it’s the returns, on the returns, on the returns….

A simple story will help illustrate the magic of Compounding Interest:

Let’s say on the first day of the month, you place one penny in an empty jar.  The second day of the month, you place two pennies in the same jar, doubling your initial contribution.  On the third day of the month, you put four pennies in the jar, doubling the previous day’s contribution.  (Go Gingham quiz:  How many pennies would you put in the jar on the fourth day?  If you answered eight, you’re correct!)  Keep going each day, putting pennies into the jar, and doubling the previous day’s contribution.  At the end of just one month, you’ll have over $21,000,000 in your jar.  That’s the magic of Compounding Interest.

So obviously you’re money isn’t going to double daily like the pennies in that jar did but your money will double over time.  And then it will double again.  That’s why Early and Often like Compounding Interest so much because once you give Compounding Interest time to work its magic, you don’t have to do too much.

We used these three friends at the beginning of our marriage to track our investment account.  Notice the amounts are not large but we started Early in our 20s and we just kept going as Often and as many months as we could.

Women in finance: understanding compounding interest

We didn’t contribute every single month but we were consistent and kept our financial goal in mind.  Compounding Interest works its magic when you start saving Early, you do it Often, and you let your investments grow.

Now, go out and play with your new friends!

This post is a part of Women’s Money Week 2012. For more posts about “Money in Your 20s, 30s, 40s, 50s, and Retirement” see Women’s Money Week 2012.

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