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- I’ve heard the term compound interest for years, but never took the time to understand it. Once I finally did, I made three money moves to take advantage of it.
- First, I opened a high yield savings account to earn more interest on my money.
- Then I hid some money in an 18 month CD compounded daily.
- Finally, I started making a monthly deposit into my retirement account – I had made one deposit per year and missed the funding.
- See Business Insider’s picks for the best high-yield savings accounts »
Throughout my journey to fix the financial mistakes I made in my twenties, I’ve heard people talk about something called compound interest. For years I didn’t take the time to understand it or learn more about it simply because I was busy trying to clean up my financial mess and get on the right track. I spent a few years paying off my debts, growing my savings account, putting money aside in an emergency fund, and slowly adding money to my SEP IRA.
But the term
seemed to pop up regularly in conversations with friends and financial experts. A few months ago, I asked my fiancé if he knew about compound interest. His answer says it all: “Yes, that’s how the rich get richer.”
Here’s a simple definition of the term: compound interest is the interest you earn on interest. Which means that if you have $100 and it pays 5% interest each month, you will have $105 at the end of the first month and $110.25 at the end of the second. You not only earn interest on your initial deposit, but also on the interest you accrued in the first month. What makes compound interest so powerful is that even if you never add another dollar to that initial deposit, the money in the account will continue to grow exponentially over time.
My a-ha moment with compound interest
Finally intrigued to learn more, I spoke to financial planner Colin Exelby, the founder of Celestial Wealth Management, who not only explained what compound interest is, but how to get the most out of it.
“As you save and invest, whether in stocks, bonds, real estate or other investments, it often begins to grow. Although this growth may or may not be guaranteed , that growth is on top of what you already save and invest,” Exelby system. “Then you can receive growth not only on what you have invested, but on that growth as well.”
I wondered how such an approach could transform a person’s money or, as my fiancé said, help a wealthy person get even richer.
Exelby explained that with compound interest, your savings can grow and accumulate and income can grow and accumulate to the point where income on growth actually grows at a faster rate than what you save.
“That’s when your money really works for you and the power of compounding is unleashed,” says Exelby.
I decided to use this strategy to adjust three main areas of my life. Here’s how it transformed my money-saving plan.
I switched to a high yield savings account
To help me take advantage of my compound interest savings strategy, I decided to transfer my money from a savings account at a bank that only offered an interest rate of 0.03 % compounded monthly to a high yield savings account that offered me 1.7% interest (although now it’s dipped way below that) and compounded daily. It was a game changer in terms of extra money – I was making a lot more due to a higher interest rate and daily compounding, instead of monthly or even yearly, and my money was growing faster .
I opened a CD that composes daily
I also decided to set aside some money that I knew I didn’t need in a high interest CD that was accumulating daily. I chose an 18 month term (so I could get a higher interest rate) and with interest compounded daily I could see the amount of money I put in the CD grow more faster than if it was sitting in my old savings account at a bank that didn’t give me much for my money.
I fund my retirement account monthly
Another big money mistake I made was not putting any money in my retirement account except for one deposit a year. I thought I would save and then make a deposit into my SEP IRA at the end of the year. But my accountant told me to reconsider this strategy because monthly contributions would pay more with compound interest than a single annual deposit (since I earn monthly interest on my SEP IRA and the interest earned is tax-deferred).