Possibly the best way that I know how to save money is by doing so using time and compound interest. It’s amazing just how much difference compound interest can make to your total bank balance, particularly when you measure it over decades.
The fortunate / unfortunate thing about compound interest though (depending on your stage of life) is that the earlier you start, the bigger the rewards you can reap.
So if you are reading this in your teens or twenties, that’s great, you have heaps of time ahead of you to really make the most out of compound interest. If you are in your 30’s and you haven’t started yet then all’s not lost, and even those who are older can still benefit, you will just have to save a bit harder to yield the same results.
As an example, my wife and I started our son a bank account not long after he was born. We decided to contribute $10 a week to his account so that by the time he was 18 he would have a small nest egg to do whatever he wanted with. I expect that when he is 18 we should have close to $13,000 (this is based on an interest rate of 3.5% PA) to give to him to contribute to his future in one way or another – $3,000 more than if I didn’t have compound interest working for me.
Now this might not sounds like a big amount of money, but it amplifies over time quite significantly. If our son was to continue with the $10 a week at 3.5% PA interest, and never remove any money, he would have $124,000 by the time he was 65. Compare that to someone who only starts saving $10 a week when they are 18, they would only collect $62,000 when they are 65. That additional $13,000 head start that my son will have access to, makes a massive difference over a longer period of time.
Extra Contributions Matter
The other thing I will point out is that $10 isn’t a lot of money to be saving, most people can save considerably more than that per week. So I will throw up another scenario. Say instead of just contributing $10 a week into our sons account, we decided to up the amount by $1 each time he had a birthday. It would look like:
- 0-12 months old = $10 per week
- 1 year old = $11 per week
- 2 year old = $12 per week
- 18 years old = $27 per week
Obviously there will be a point where this may get challenging for some people to fund, particularly if you are trying to do this for multiple people, but assuming you are able to contribute the extra $1 per week per year this is how things pan out.
My son would now hit 18 years old and have $22,000 ($17,000 without compound interest) instead of $13,000. Adding the extra $1 per week per year has made a significant difference to the overall balance. If he was to continue it until he was 65 years old, he would be able to collect $382,000. If I compare this to the person who starts saving at 18 (using the same extra $1 per week per year scenario), they would hit 65 with $164,000, $218,000 less than the person who started at birth.
The following shows how you finish up at 65 under the $1 extra per week per year scenario depending on when you start:
- Start at 0 years = $382,000
- Start at 18 years =$164,000
- Start at 25 years = $116,000
- Start at 30 years =$87,000
- Start at 35 years =$63,000
- Start at 40 years =$44,000
- Start at 45 years = $29,000
- Start at 50 years =$18,000
- Start at 55 years =$10,000
- Start at 60 years =$4,000
While it is fairly obvious that starting younger has some pretty big benefits, it doesn’t mean that you are destined to be broke if you start later in life. All it means is that you have to contribute more each week to reach the same outcome.
The other thing that I haven’t really gone into too much detail on is the interest rate. One of the best ways to catch up is to find something that returns better than 3.5% per year. I only used 3.5% per year in my examples because that is the interest rate I am currently getting for my sons account. If you wanted to dabble in shares or other higher return investment types, then the returns will be far larger.