27 Apr Taking the Pain Out of Budgeting (Part 3): What’s the Big Deal About Compounding?
At first, seeing our money grow seems like an excruciatingly slow process. It’s so slow that too many it seems futile – not worth the effort. When developing a new skill, we face the same dilemma. It’s hard to envision being an expert. Consistent persistence yields amazing results. Similarly, at first consistent neglect doesn’t seem to matter; however, with time tragic outcomes are inevitable. In short, the Power of Compounding is a rule of life that works either for us or against us.
Let’s create a simple example. Let’s say you can save $400 each month over the next 5 years. This means each year you’ll save $4,800. Let’s also assume you’ll earn 6 percent interest on your money. Here’s an easy formula you can use: 4800*(1+.06)^5. The $4,800 saved in the first year will be worth $6,423 at the end of five years. So, to figure out how much you’ll have for the dollars saved in the second, third, fourth and fifth years, here’s what you do.
$4,800*(1+.06)^5 = $6,423 The value of the dollars you saved in your first year.
$4,800*(1+.06)^4 = $6,060 The value of the dollars you saved in the second year.
$4,800*(1+.06)^3 = $5,717 The value of the dollars you saved in the third year.
$4,800*(1+.06)^2 = $5,393 The value of the dollars you saved in the fourth year.
$4,800*(1+.06)^1 = $5,088 The value of the dollars you saved in the fifth year.
The total that you amount you will save in 5 years is $28,682! Our example assumes that you are starting with $4,800. If you couldn’t do this and are just starting your savings program, at the end of five years, you will have $27,908. With each additional year, the impact of keeping your dollars working continues to grow.
If you already have $4,800 lazy dollars that you’ve kept in your checking account and begin putting these dollars to work and over the next five years add $400 a month, you’ll have $33,813. At the end of twenty years, you’ll have saved a whopping $127,071!
Just imagine, each year when you get a raise you put a little more aside. Over the last twelve months, you’re already adjusted to living off of the amount you earned before the raise. If you put more aside, you won’t miss a thing. I promise!
Click on the link below and take a look at this Ted Talk called ‘Saving for Tomorrow, Tomorrow’. http://www.ted.com/talks/shlomo_benartzi_saving_more_tomorrow.html
If $400 a month is all you need and you are already saving this amount – great! However, if you’d like to save more, what should you do?
Start carrying your list of priorities with you. Before you purchase an item, ask yourself, ‘Is what I’m about to purchase more important to me than the priority I’ve got on my list?’ You’ll begin finding it much easier to save. The best part is you won’t feel like you are giving up a thing! What you’ll begin to experience is a desire to find other ways of finding more dollars to save. You will have begun a small yet powerful mind shift that will accelerate over time. Small successes will motivate you to achieve greater achievements.
If $500 per month were saved over 5 years, you will have $35,852
If $600 per month were saved over 5 years, you will have $43,022
If $700 per month were saved over 5 years, you will have $50,193
Here’s another question worth asking, “What am I willing to purchase today that’s worth erasing my future dream?”
There’s a saying I repeat to myself, ‘Small changes bring big results’. Small changes can be either for the good or the bad. Making small changes is like creating a snowball – it continues to grow. As it grows, the growth accelerates and the impact catches us by surprise. This is what the phrase, ‘the power of compounding’ means. Once you’ve caught this vision. You’ll be ready to start budgeting.
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