Wednesday, April 30, 2008

Financial Advisor: Savings Calculators and Compounding Interest

Personal Finance: Savings Calculators and the Power of Compounding Interest

In my last post I explained the importance of savings small amounts of money over time. As you all saw this is very important in achieving your goal of financial freedom and is not something that can be ignored. You also saw calculating what saving can do for you can be done very easily through the use of a savings calculator.

This post is intended to show how financial freedom can be achieved easily if someone just has TIME and small amounts of savings. It shows how starting today with small amounts of money will help you to have millions of dollars in the future and experience personal financial security. I have once again included a savings calculator for your use and also used a savings calculator for all of the calculations I have included.

What if I told you that if a person wanted to achieve financial freedom and take control of your personal finances and be extremely comfortable with their financial situation at retirement it would only take $20,000 of investments. Most of you probably would not believe this but I am going to show you how this can be done. This is a very basic tip financial advisors tip that all people should know about. The ultimate key to financial freedom is time and money. Not a lot of money but a lot of time and some money.

The concept I will be explaining today is the power of compounding interest and how you can using savings calculators. Compounding interest is very important in relation to personal finance. You can find many very good examples explaining the power compounding interest on the Internet but most fail to provide simple examples that are easy to relate to. Here I have include an example that should sum it up for my readers. This example will show you how easy it is to achieve financial freedom and take control of your personal finances


There are two 18 year old students that are about to graduate from high school. When they graduate they both receive gifts from their parents. Their parents goal is to help them achieve financial freedom at retirement and have enough to live off of.

Jim gets $20,000 from his parents and puts it into a savings account while John gets $20,000 and puts it into a mutual fund. Jim's parents have also agreed to deposit another $20,000 into his savings account each year until retirement. Jim's parents are well off and feel that giving him another $20,000 each month will help him to have a larger amount of money at retirement and give him more financial freedom.

In both situations the children agreed to not spend their graduation gifts until they retire.

Sounds like John got the shaft and Jim has an amazing deal right? Wrong! Think again! I will explain below.

For this example we will assume that Jim's saving account earns 3% per year and John will earn 10% per year through the stock market. Then we will use a basic savings calculator to find out how the numbers shake out.

After getting these gifts Jim and John decide that they will compare the values of their accounts at each 10 year high school reunion and then at retirement. The results are listed below.

10 Year Reunion: At their 10 year reunion, Jim and John compare accounts. John's account is now valued at $54,140 and Jim's account is valued at $232,948. Naturally John feels like he got burned in comparison to Jim. Both individuals are and the right track in achieving financial freedom but time will show that John is actually better off.

20 Year Reunion: At their 20 year reunion, Jim and John once again compared accounts. John's account is now valued at $146,561 and Jim's account is valued at $547,279. Naturally John still feels like he didn't get a good deal. Both of them are now 38 years old and are certainly on their way to financial security.

3 0 Year Reunion: At their 30 year reunion Jim and John compared account for a third time. John's account is now valued at $396,748 and Jim's account is valued at $977,422. Of course John still feels like Jim got a better deal.

Retirement Reunion: John and Jim both decided to retire at 68 years of age and that this time get together again to compared accounts. Now John's account is valued at $2,907,398 and Jim's account is valued at $2,314,612.

There you have it. John's parents gave only $20,000 while Jim's gave exactly $1,000,000 and yet John ended up with more money in the end. This is due to the power of compounding interest. John only ended up with more money because he was making 10% per year for a long period of time while Jim was only earning 3% per year. This is a powerful example that shows how taking control of your personal finances today and beginning to save can help you in the future.

All the while Jim is happy to take is $2.3 million dollars but does not realize that if he would have had his money in a mutual fund at 10% instead of his 3% savings account he would have had over $28 million at retirement.

I hope you can see from my post how important the power of compounding interest is and how saving often and early in live can help you to reach your goal of financial freedom.

Please follow this simple personal finance tip and get started on your way to financial freedom.

Here I have again included a savings calculator for you convenience. Just put in the numbers you feel are correct for you and see how it comes out.


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