How many of you consider the effects of compound interest (or “compound returns”, if you prefer) when you make financial decisions? I mention the concept from time-to-time — and I’ve even devoted whole articles to the extraordinary power of compound interest — but I don’t know if others keep the notion in mind when they work with their finances.
When I was younger, when I was struggling with money, I only had a fuzzy notion of how compound interest worked. Well, I knew how it worked, but it seemed abstract, as if it had no relevance to my own life.
Now, though, I often keep compounding in mind when I make financial decisions. As I make choices, I actually visualize little graphs in my head. (I’m a geek, what can I say?)
I was rummaging around Money Rates yesterday while researching my post on how to find the best bank accounts. During the process, I found an interesting compound interest infographic about how one percent can make a huge difference in retirement savings:
Click through to view the entire graphic.
This infographic does a great job of demonstrating just how powerful compounding can be — and how important it is to get the best rates possible:
By spending just a little effort to find the best interest rates, the Wynns keep their money working harder for them…The 1% difference in interest rates ended up giving them 38% more in annual retirement income!
As I’ve mentioned in the past, I’m not a rate-chaser. Not yet. But sometimes I wonder if I shouldn’t be. Especially as I begin to build wealth, even one percent annually can make a huge difference in my nest egg. (Right now, it doesn’t really make sense to chase the highest bank rates, either. Everyone’s rates are low. But in a few years, as interest rates rise, I expect to see greater differentiation between various banks.)
This is also something I consider as I begin to invest more of my money. I understand that the historic returns of the stock market are about 10% annually. But I also know that average is not normal. Like everyone, I want the maximum possible investment return with the minimum possible risk. I know that if I can get 12% annually, I’ll reach my goals more quickly than if I get 8% returns.
But I look at how many people were burned during the recent stock market crash, and it makes me think that the risk of reaching for 12% might not be worth it. With proper diversification, and by being conservative with my money, maybe I can obtain decent growth without risking my savings.
It’s a tough balance to achieve because — as the Money Rates infographic show — one percent can make all the difference.