A Little Difference With Compound Interest

Sometimes the difference between success and failure is very small. Occasionally you’ll see a race (NASCAR, horse or foot) that will be decided by just an inch or two. Such a tiny amount determines winners and losers.

What’s also striking is how much difference that can make in the future. Our stock car winner will take home a bigger prize purse. They’ll find it easier to get sponsors. Winning opens many doors.

A similar thing happens in personal finance. The difference between financial success and failure is really quite small. And, somewhat surprisingly, it’s not tied to being more disciplined or working harder your entire life. It’s a simple rule of economics that can work for or against us.

What is it that makes such a difference? It’s compound interest. Truly the double edged sword of personal finance.

When it’s working for you, compound interest is a wonderful thing. If you save a dollar today and invest it (earning interest or profit). It will be worth more tomorrow and still more the day after that. If you wait long enough even relatively small amounts can grow quite large.

Let’s take a look at the difference between saving/investing $1000 and spending/borrowing the same amount of money.

To save $1000 requires some effort on the front end. You’ll need to find a way to accumulate the money. After that you’ll decide where to invest it. From that point on it’s just a matter of monitoring your investment. No heavy lifting required.

That $1000 you saved, if invested today earning 9% (the long-term average for stocks) would be worth $2367 in 10 years, $5604 in 20 years, or $13,268 in 30 years. Again, that’s just from the initial investment. You don’t need to add anything to the account.

What happens if you end up on the other side of the coin? If you borrowed and spent $1000, you’ll be paying interest on the borrowed money. That requires you to work to earn the money. Over and over again. At 15% (a fairly typical rate on credit card accounts) you’ll need to come up with $150 just to cover the interest every year.

So borrowing that grand will cost you $1500 in interest payments in 10 years, $3000 in 20 years, or $4500 in 30 years.

What would happen if you made two decisions. One to not spend/borrow the $1000 and another to save $1000. How would that work out. Well, in 30 years the difference in what you would have spent in interest payments and what you would have saved works out to over $16,700.

Now I can hear you say that $1000 is a lot of money. How could you manage come up with that much?

OK, let’s mention just a few simple ways. Skipping a $3 latte every day would save $1095 in one year.

Or bringing in your lunch three days a week. Saving about $4 per lunch or $624 in one year. Saving a grand takes less than two years.

Most of us can find a place or two where we could save $10 to $15 a week. But, maybe you’ve already cut your spending down to essentials. There’s no place to cut anymore. In fact, you’re depending on credit
cards to put food on the table.

If that’s the case then consider getting a McJob in your off hours until you earn the $1000. No one’s asking you to work two jobs forever. If you earned $8 per hour and worked just 10 hours per week, you’d have your $1000 in just 13 weeks. So taking a part-time job for 3 months could mean that you’ll have $13,268 in 30 years. That’s pretty good pay for a little part-time work.

What’s the point? The difference between being in good shape financially and always struggling with money isn’t that big. Often it doesn’t take a superhuman effort to put off borrowing money or to save a little. But the results for those who do make the effort can be very big. And that makes the effort very worthwhile.

Gary Foreman is a former financial planner with over 30 years experience in getting value for a dollar. He currently writes on personal finance and edits The Dollar Stretcher website. You can follow Gary on Twitter.