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- I 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.
- First, I opened a high-yield savings account to earn more interest on my cash.
- Next, I tucked some money away in an 18-month CD that compounds daily.
- Finally, I started making a monthly deposit to my retirement account — I’d been making one deposit annually and missing out on compounding.
- See Business Insider’s picks for the best high-yield savings accounts »
Throughout my journey to fix the money mistakes I made in my 20s, I kept hearing 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 a good path forward. I spent a few years paying off debt, growing my savings account, putting aside money in an emergency fund, and slowly adding cash to my SEP IRA.
But the term compound interest 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 response spoke volumes: “Yes, it’s how the rich get richer.”
A simple definition of the term is this: Compound interest is the interest you earn on interest. Which means if you have $100 and it earns 5% interest each month, you’ll 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 original deposit but also on the interest you accumulated during month one. What makes compound interest so powerful is that even if you never add another dollar to that original deposit, the money in the account will still 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 make the most of it.
“As you save and invest, whether it’s stocks, bonds, real estate, or other investments, it often begins to grow. While that growth may or may not be guaranteed, that growth gets added on to what you are already saving and investing,” sys Exelby. “Then, you can receive growth not only on what you invested but also that growth.”
I wondered how an approach like this could transform a person’s money or, as my fiancé said, help a rich person up their wealth even more.
Exelby explained that with compound interest, your savings can grow and build and the earnings can grow and build to the point where the earnings on the growth actually grow at a faster rate than what you are saving.
“That is when your money is really working 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 leverage my compound interest savings strategy, I decided to move my cash out of a savings account at a bank that only offered 0.03% interest rate that compounds monthly to a high-yield savings account that offered me 1.7% interest (though now it has dipped well below that) and compounds daily. This was a game-changing move in terms of the 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 compounds daily
I also decided to tuck away a chunk of cash that I knew I didn’t need in a high-interest CD that compounded daily. I picked an 18-month term (so I could get a higher interest rate) and with daily compounded interest, I was able to watch the amount of money I put in the CD grow faster than if it was sitting in my old savings account at a bank that wasn’t giving me much for my money.
I’m funding my retirement account monthly
Another big money mistake I was making was not putting any cash into my retirement account except for one deposit a year. I figured I’d save up and then make a deposit into my SEP IRA at the end of the year. But my accountant told me to reconsider this strategy since monthly contributions would earn more with compound interest than a one-time yearly deposit (since I earn monthly interest on my SEP IRA and the interest earned is tax-deferred).
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