Investing The Power of Compound Interest
October 14, 2020
Investing your money can appear extremely complicated and time-consuming but, once you’ve mastered your current financial situation, it can help you take your finances to the next level. After working at a cupcake shop during my summers in high school, I found myself wanting to invest some of my earnings but was unsure where to start. I had never made any investments before. I thought investing was only something done by professional financial advisors or big corporations. I was really at a loss about where to begin. At the same time, I didn’t want to leave my earnings in a simple savings account because I knew that it could reduce my purchasing power over time. Most savings accounts have interest rates lower than the rate of inflation, so I knew I was at risk to lose some money. I realized that I had to do something.
So how does a high school (and now college) student, who doesn’t know much, go about investing any extra cash they may have? Well, I can tell you what I thought were the most logical steps to take:
I looked up articles and guides about how to start investing in stocks and bonds on Investopedia. Through these readings, I realized that, given my limited knowledge base, I had little interest in actively managing and selecting individual stocks and bonds. So, I turned to learn about passive investments (which select the stocks for you) such as mutual funds.
Once I read up on mutual funds, I learned what a brokerage account was and how to open the account.
After going through that research process, I decided to open a brokerage account with TD Ameritrade and invest in mutual funds. Through the TD Ameritrade phone app, I was provided with suggestions about different mutual funds and selected one that was well diversified (it owned stocks in companies across different industries) and had a decent expected return. Again, since I was choosing to passively manage my money, I wasn’t checking the status of my investments every day but rather every couple weeks or whenever big news stories appeared.
When I reflect back on my initial investing experience, I realized one big takeaway: the power of compound interest.
When you invest, your account earns compound interest. This means, not only will you earn money on the principal amount in your account, but you will also earn interest on the accrued interest you’ve already earned. The idea of compound interest (as compared to simple interest) is fundamental to investing because it can ultimately lead to a greater return in your account.
For example, I may invest $1000 into a mutual fund and receive an 8% return, during the course of a year, leaving me with an account balance of $1080. Now, with compound interest, if I decide to invest the $1080 into the mutual fund with an 8% return, I will have an account balance of $1,166.40 after the second year. This is different than if I just earned the simple 8% interest on the principal amount of $1000 which would leave me with an account balance of $1160 after two years. Now, just think about if you invested over your whole professional career (assume 35 years) and continued to earn compound interest, you would be returning A LOT of money to your wallet!
All of this is to say, investing can be incredibly beneficial to securing your financial success.
My advice to you: If you’re nervous about investing for the first time and scared about losing your money in the market, that’s extremely valid and okay. With that in mind, you may want to begin investing as early as your financial situation allows for so that you can reap the benefits of compound interest. Also, unless you have the time and are willing to put in the effort to individually select out stocks and bonds, I’d suggest investing in mutual funds that will do the work for you.
Ultimately, how you invest is up to you and your preferences. Above all, I’d encourage you to be mindful of your current financial situation and your risk tolerance for investing.