WHAT YOU NEED TO KNOW ABOUT COMPOUND INTEREST

Compound interest

Guest Post by Retired Broker.  Follow him here and read George’s Blog here.

 

Cash savings are dire; there are no two ways about it. Once inflation is taken into account, the buying power of almost all the accounts currently available will be less than when you started. So is there any point in using them? Well, probably!

 

The fact of the matter is that a home for spare cash, no matter how modest, will always be required. So how do you make the best of this not so great situation?

 

There are a couple of ways to approach it which require a little effort and some patience. The first thing to grasp is the magical powers of “Compound Interest”.  Compound Interest is where your savings accrue interest, and then that interest will also accrue interest and over time the rate of growth gets faster.

 

It’s a slow process, but worthwhile, especially if you have long term goals. A little while ago I posted a blog about how much is spent over a year by buying a take away coffee every day for work, here’s the link  http://theretiredbroker.com/coffee-mugs.

 

You might need something stronger when you read it! For the purpose of a compound interest illustration, let’s assume that you are going to give up one coffee a week and put that money away in a regular savings account.

 

That’s £2.55 a week or £11 a month (yes I know it works out at £11.05, but I’ve rounded it down ok?) A quick look at some comparison sites will see that a few regular savings accounts will pay 2% or more, so for the purpose of this exercise we’ll use 2%.

 

The table below shows how much £11 a month will grow at 2% over different numbers of years.

 

 

1 yr £133.22
3 yrs £407.77
5yrs £693.52
10yrs £1459.92
15yrs £2306.84
20yrs £3242.77

 

While fully understanding that interest rates will change and that inflation will erode the actual buying power of the money, the point here is that it is money that you would otherwise not set aside. Even a modest amount such as £11 a month may be really useful in all those years time.

 

If you look at the 20 year period, the actual amount paid in amounts to £2640, so that is an actual growth of £600. Could be ideal if you have a young family and want to set something away for university, car or travel.

 

The other advantage of regular savings is that you can adjust what you save as time goes on or add any spare windfall you may get. This brings me to the second advantage, which does require a tiny bit of effort. A lot of these regular savings accounts offer a rate of interest for a set period only, usually a year.

 

After this the rate will either tumble or collapse. If you don’t stay on top of it, your savings will stagnate. So you need to remember that Cash Rates Are Portable. That’s right remember interest rates are C.R.A.P. So you need to treat them like your annual home or car insurance and review them every year.

 

Once you have come to the end of a good interest rate, shop around’ find another good rate and transfer your savings over to the new account and continue with the monthly saving, you may just be glad you did!

 

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Compound interest

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