" Compound interest is the 8th wonder of the world, those who understand it, earn it, those who don't.. pay it." Albert Einstein
Compounding returns is very important to investors as they create a plan to achieve their financial goals. Many people understand this concept, but often times never see it in action. Let’s start by looking at a quick example, if you save $5 dollars per each work day (about the price of a coffee from Starbucks), the equals $100 per month. If you add $100 per month to an investment account that generates 5% returns per year (well below the long-term average of the S&P 500), after 20 years, the account will be worth over $41,000! A 10% return will create an account value over $75,000.
$100 invested per month for 20 years compounded at 5%
$100 invested per month for 20 Years compounded at 10%
How can a recent graduate benefit from the power of compound?
- Create a budget – At the beginning of your working career, this can be difficult as there are a lot of uncertainties around your income potential as well as what your expenses will be. But it is a good practice to start a budget, even if it needs to be changed over time, so that the process is familiar to you and something that you continually refine.
- Student loans – If you have them, make sure you understand the terms. Try to start making payments as soon as possible. Interest will be accruing outstanding loans balances. Consider paying more than the minimum due in order to reduce the amount of interest paid in the long-run.
- Set up an emergency fund – 3-6 months of living expenses is the general rule of thumb for an emergency fund. This can be used as a buffer in the case of a job loss, or to help pay unexpected expenses such as car repairs or medical bills
- Start investing early – “Pay yourself first” means setting aside money for savings before spending on other things. Even if this starts out at $100 per month, it creates a habit of saving and investing. If the company you work for has a 401K employer match, try to contribute at least the maximum of what the company will match. This reduces your taxable income as well as adds the company’s matched dollars to your retirement account.
- Use credit wisely – The average annual interest rate on credit card debt is currently over 20%, so paying just the minimum means that you are incurring big interest charges (which ultimately can be viewed as increasing the prices that you paid for all the things on your credit card). Avoid taking on more debt than you can handle and try to pay any balances as quickly as possible.
- Network – Work hard to grow your professional and personal network. This s a great way to invest in yourself and improve your skills which could lead to better job opportunities and higher income in the future.
The transition to the workforce can be overwhelming and these are just a few ideas to work on as you begin your financial journey. If you or your children have any questions or need advice on where to get started, please contact us at (973) 635-4275 or www.chathamwealth.com