Working Hard for Your Money vs. Making Your Money Work Hard for You

Working Hard for Your Money vs. Making Your Money Work Hard for You

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In pursuit of big financial goals, the average person often faces near impossible headwinds in the form of taxes that eat away at growth and inflationary pressures that devalue purchasing power. Thankfully, there are a few simple things you can do to mitigate these challenges and achieve your big financial goals. Let’s gain a better understanding of how to make your money work for you.

“Compound interest is the eighth wonder of the world. He who understands it, earns it; he who doesn't, pays it." - Albert Einstein

First, it’s important to understand the difference between simple interest and compound interest and how each one affects your savings goals. Simple interest, the kind earned in your typical bank savings account balance, is calculated on the principal amount only. Compound interest, on the other hand, is calculated on the principal + interest earned during the previous crediting period.(The simplified examples below do not reflect real world circumstances: in many cases, interest rates are less and taxes higher)

Simple interest accounts are great for holding your $500 emergency fund, but they’re an inefficient repository for long-term savings goals or investments because you’re taxed-as-earned and the amount of interest you earn is based solely on the principal held in the account during the crediting period.

Example 1: Saving $1 per day over a 5 year period with interest and taxes applied

*initial period

Unlike a simple interest account, compound interest accounts are credited on the principal + interest gained during the previous crediting period. Given time a compound interest account can lead to significantly higher returns because it’s based on self-reinforcing outcomes: the more money you save, the more interest you’ll earn. And if you pick the right type of compound interest account taxes won’t be a cause for concern.

Ultimately, the best type of account will depend on financial goals and risk tolerance.

Saving for short-term goals using a traditional, simple interest savings account is reasonable and better suited from a tax standpoint. Long term goals intended to grow into the tens, hundreds of thousands or more are best nurtured where taxes and inflation won’t become an issue.

Here are some tips for using a compound interest bearing account:

• Start saving early. The sooner you start saving, the more time your money grows through compound interest.

• Choose wisely. Choose accounts that feature compound interest, a high average rate of return and predictable results.

• Know your risks & threats. Taxes, inflation and the potential of loss combined or on their own can derail even the most well-funded accounts.

• Exercise discipline. 7 to 12 years of disciplined saving can lay the foundation for financial freedom.

• Be patient. It takes time for compound interest to work its magic.

  Questions or requests for more information should be directed to Damaris@ 310.388.8212