Long Term Savings - Compound Interest
Have you heard of compound interests? Do you know much about the topic? Today I'm going to give you a quick break down so you have absolute clarity next time it comes up in a conversation. To help you get better clarity I have also attached a link to a spreadsheet you can download with some examples for you to play around with and a Youtube tutorial.
Once you've got clarity on your current financial situation and mapped out a plan for the near future you might start thinking about the long term. If you haven't already, you should go and have a read on my blog post on personal finance tips. When you put money aside as savings you might consider various options, an I'll quickly walk you through the 3 main ones to ease our way into compound interests. 1.) Saving at home
The first option you might consider is to take your money home and hide it somewhere safe. Now what you should know is that each year the value of money changes, due to inflation. As the average price of goods and services increases, the value of your money decreases. As an example say you save 1,000 each year for 10 years. At the end of the period you would have saved 10,000.
2.) Opening a savings account at a bank The second option you might consider is holding your savings in a savings account at the bank. The typical interest rate you would receive is anywhere from 1% to 3%. This will depend on what kind of savings account you have gone for. If it is an easy access (meaning you can withdraw your money without penalty) the rate will will be worst. If it is a fixed term savings account, so you can't take money out for 2 or 3 years then the interest rate will be higher. This is a low risk investment, but still an investment. It is not guarantied you will get this return on your savings. Here is an interesting article on how the interest rates might become negative in the UK due to the impact of the pandemic on the economy. To continue on our previous example 1,000 over 10 years at a 3% interest rate will give you a return of 12,808 at the end of the 10 years.
3.) Investing in the Stock Market And finally you might consider investing in the stock market. This is where you will have the opportunity to gain the highest amount of return on your investments. However, do remember that where there is higher return it is because there is higher risk. There is a lot of volatility in the stock market as we have heard over time, but we will dive further into this topic on another occasion. If we consider that you invest your money in a fund that replicated the index fund and your average return of 10 years is at a 10% interest rate, then your annual investment/savings over 10 years would now be 18,531. As you can see in the 3 different scenarios the amount of money you put in is always the same 10,000. The higher the interest rate is, the higher the annual return on your investment. Meaning the following year your starting base is higher and therefore the return generated will be on your initial investment + the return made. So year 1 = 10,000 * 10% growth = return of 1,000, therefore year 2 = (10,000 + 1,000) *10% =1,110 and so on. I hope you've found this helpful.