Financial Education: Pay Yourself First

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How Money Grows

Making regular payments to yourself, even in small amounts, can add up over time. The amount by which your money grows depends on the interest earned and the amount of time you leave it in the account.

Here's an example of your money not growing:

If you have $1,000 stashed away under your mattress for 1 year, it will still be $1,000 at the end of the year. Your mattress is not paying you interest for keeping your money.

Now let's look at interest and the power of compounding. This is how your money can grow.

When you compound interest, you earn money on the interest you leave in your account. Interest can be compounded daily, monthly, quarterly or annually. Not all savings accounts are created equal!

Compound Interest Exercise:

$1,000 @ 5% compounded annually earns $50 of interest at the end of one year. (You made more than if you kept it under your mattress!)

If you deposit $1,000 in an account that has daily compounding, at the end of the first day you would have $1,000.14. ($1,000 @ 5% divided by 365 days)

The next day, the interest is calculated based on the entire amount of your original deposit of $1,000 PLUS the previously earned interest -- $1,000.14 rather than just $1,000.

By the end of one year you would have $1,051.27. The extra $1.27 does not seem like much at this point. However, the table below shows the difference it makes over time.

Interest Type 5 Years 10 Years
No Interest $1,000 $1,000
Annual Compounding at 5% $1,276 $1,629
Monthly Compounding at 5% $1,283 $1,647
Daily Compounding at 5% $1,284 $1,649

This table uses the same $1,000 to show how your money grows faster the more often interest is compounded and the longer it stays in the account. The 14 cents adds up over time!

The table below shows that even small amounts of savings add up. Look what happens when you save just $1 a day.

Years No Interest 5% Daily
Compounding
Year 1 $365 $374
Year 5 $1,825 $2,073
Year 10 $3,650 $4,735
Year 30 $10,950 $25,415

At the end of year 1, you would make an extra $9 compounding interest. The real power of compounding shows at the end of 30 years, you would make an extra $14,465!

The table below shows what happens to your money when you save just $5 a day. Look at the difference when your money is invested in an account that compounds interest daily.

Years No Interest 5% Daily
Compounding
Years 1 $1,825 $1,871
Years 5 $9,125 $10,366
Years 10 $18,250 $23,677
Years 30 $54,750 $127,077

The table shows a difference of only $46 at the end of the first year. However, compounding daily after 30 years show a difference of $72,327!