We’ve all heard of the Seven Wonders of the World – but in the world of financial planning, there is an eighth. “Compound interest is the eighth wonder of the world. He who understands it, earns it; he who doesn’t, pays it.” – Albert Einstein.  The basic understanding of compound interest is the idea of not only earning interest on your principal, but also earning additional interest on the interest you’ve already earned. This is what allows your wealth to grow faster.  

Those who save have the ability to earn compound interest; those who take on debt (e.g., credit card debt), pay it. At Summit, we help clients reap the benefits of compound interest through investing. At the same time, we review their debt situation and help them prioritize paying down high-interest debt first, so they can stay on the positive side of earning compound interest (versus paying it).

Time is the true beauty of compound interest. The earlier you can begin saving, the earlier your money can begin working for you every day–and the earlier you can have financial independence. Let’s look at two different examples.

Example 1.

The first example is impacted by time.

Susie started saving while she was working in college; John waited to start saving following a career change and going back to college. Susie and John each started with $1,000 and an annual estimated return of 7%. Susie began investing at age 20, saving $1,000 per month. Upon retirement, at age 60, she has $2,641,125 saved. John began investing at age 30, saving $1,000 per month. Upon retirement, at age 60, he has $1,228,087 saved. Susie earns nearly 2.5 times the interest John earned while only contributing $120,000 more than him.   

Example 2.

The second example is impacted by time, too, and also illustrates the “Rule of 72” (a formula used to estimate how long it will take for an investment to double in value based on a fixed annual rate of return). 

Tom and Jeanette both accumulate cash in their checking accounts – but Tom learns about the power of investing earlier than Jeanette. When they begin investing, let’s assume that they both take $100,000 they accumulated in their checking accounts and transfer to a brokerage account, which is invested and earns an annual estimated return of 7%. Tom transfers the funds at age 30 and doesn’t save any additional funds. Tom retires with $1,497,446. Jeanette transfers the funds at age 40 and doesn’t save any additional funds. Jeanette retires with $761,226. This scenario nicely illustrates the “Rule of 72.” Tom experiences nearly one more doubling than Jeanette because he started investing 10 years earlier.   

One area of financial planning that involves compound interest is cash flow and retirement planning. (As illustrated above, time and returns play a key role in saving for retirement). We work with our clients to understand their cash flow needs and financial goals throughout their career and, in retirement, come up with a savings and investment plan that fits each individual client.

IMPORTANT DISCLOSURE INFORMATION

Please remember that past performance may not be indicative of future results. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product (including the investments and/or investment strategies recommended or undertaken by Summit Financial Strategies, Inc. (“SFS”), or any non-investment related content, made reference to directly or indirectly in this newsletter will be profitable, equal any corresponding indicated historical performance level(s), be suitable for your portfolio or individual situation, or prove successful. Due to various factors, including changing market conditions and/or applicable laws, the content may no longer be reflective of current opinions or positions. Moreover, you should not assume that any discussion or information contained in this newsletter serves as the receipt of, or as a substitute for, personalized investment advice from SFS. To the extent that a reader has any questions regarding the applicability of any specific issue discussed above to his/her individual situation, he/she is encouraged to consult with the professional advisor of his/her choosing. SFS is neither a law firm, nor a certified public accounting firm, and no portion of this content should be construed as legal or accounting advice. A copy of SFS’s current written disclosure Brochure discussing our advisory services and fees is available upon request or at www.summitfin.com. Please Note: If you are a SFS client, please remember to contact SFS, in writing, if there are any changes in your personal/financial situation or investment objectives for the purpose of reviewing/evaluating/revising our previous recommendations and/or services, or if you would like to impose, add, or to modify any reasonable restrictions to our investment advisory services. SFS shall continue to rely on the accuracy of information that you have provided. Please Note: If you are a SFS client, please advise us if you have not been receiving account statements (at least quarterly) from the account custodian.