How your money can grow

Grow Your Money

This week’s column continues our series of up-to-date tips and reports which will help a family prepare a reasonable, affordable financial plan with a goal of achieving financial freedom.

Savings is the first step of good money management. Making regular payments to yourself, even in small amounts, can add up over time. If you start saving your money in an interest-earning account, like a savings account at a bank or credit union, the amount of interest you’ll earn depends on three factors:

  1. Interest rate – the higher the interest rate, the more your money grows

  2. Time – how long you keep the money in the account will affect how your money grows. The more time your money has to grow, the better!

  3. Interest payments – how your bank pays you interest is very important. Almost all banks compound interest.

Interest

Interest is an amount of money banks or other financial institutions pay you for keeping money on deposit with them. It is expressed as a percentage and is calculated based on the amount of money in your account.

Here’s an example of your money not growing. If you have $1,000 stashed away under your mattress for a year, it will still be $1,000 at the end of the year, providing that it has not been lost or stolen. Your mattress is not paying you interest for keeping your money under it.

Compound interest

Compounding is how your money can grow when you keep it in a financial institution that pays interest. When the bank compounds the interest in your account, you earn money on the previously paid interest, in addition to the money in your account. But not all savings accounts are created equal. This is because interest can be compounded daily, monthly, or annually.

The tables below illustrate how compound interest works.

ANNUAL VS. DAILY COMPOUNDING

 The more frequently interest compounds, the faster it grows.

ANNUAL COMPOUNDING

DAILY COMPOUNDING

Start with $1,000At 5 percent, compounded annually.

 

At the end of the first day, still $1,000

 

 

At the end of the year, $1,050.00 – $50, or 5 percent of $1,000 added to the original deposit

Start with $1,000At 5 percent, compounded daily.

 

At the end of the first day, $1,000.14

On the second day, add the interest earned, 14 cents, and compound the total amount – $1,000.14

At the end of the year, $1,051.27. compounding each day’s interest rate added to $1,000

 

Total: $1,050.00 Total: $1,051.27

COMPOUNDING INTEREST OVER TIME

5 years

10 years

Mattress compounding –NO interest

$1,000

$1,000

Annual compounding at5 percent

$1,276

$1,629

Monthly compounding at5 percent

$1,283

$1,649

Daily compounding at5 percent

$1,284

$1,649

14 cents adds up over time when compounded daily!

You may be thinking that the concepts of interest and compounding interest over time sound terrific when interest rates are at 5 percent, but currently interest rates are much lower, so why bother?

In the previous column, we addressed why we need to be better savers. Even with a low interest rate, we need to save money for future goals and emergencies, and the money needs to be in a safe place. As discussed, under the mattress isn’t a safe place. And in time interest rates will go up. If you start or continue the habit of paying yourself first each month and putting that savings in the bank, you’re going to build your savings. As interest goes up, your money will grow.

For more information, please stop by the office at 1600 Dr. Martin Luther King Jr. S. S., St. Petersburg, or call us at 727-821-6897. You can also look us up on the web at www.nhsfl.org.

NHS is a 501 (c) (3) HUD approved nonprofit housing counseling organization. Services are provided free of charge. Partners include the U. S. Department of Housing and Urban Development (HUD), HomeFree USA, Florida Hardest-Hit Fund, Pinellas County Community Development, and the City of St. Petersburg. Sources for this article include the FDIC Money Smart program and Hands on Banking (Money skills for life), a financial education curriculum provided by Wells Fargo as a public service.

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