By Richard W. Stout III
We all have to be young before we can be wise. For many, this mantra mirrors their relationship with money. To become financially wise, we need to learn key principles, many of which we wish someone would have shared with us earlier in life.
Whether you’re a parent, grandparent, or young adult, I want to share a few principles I wish I had grasped at a younger age. Whatever stage you’re in, I hope they either help you directly or you take the time to share them with someone who looks to you for guidance in life.
This isn’t just a blanket “start saving and avoid debt” message—it’s deeper than that. What I wish I had known about money when I was younger:
- The power of compound interest and returns
- How money can be a tool for both good and bad
- How our emotions affect our money habits
The Power of Compound Interest and Returns
Gains on gain, interest on top of interest—that’s the power of compound interest or returns in a nutshell. Compound interest is most often received from a savings account that earns interest through a bank. It’s a concept most easily understood through examples.
Each month, the bank pays you interest. The payment is a percentage of your account balance. If your interest rate is 0.5% and your account balance is $10,000, you’ll see a deposit of $50. If you leave the account untouched, next month your interest rate will still be 0.5% but your balance is now $10,050, and the interest payment increases to $50.25.
While at 0.5%, compound interest doesn’t give you much to talk about, putting this same money into the stock market and seeing compound returns may have you running to the rooftop. When your money is in the stock market, the balance will fluctuate. Using our $10,000 example, let’s say you saw a 10% return last year. That means your new balance is $11,000. Likely the easiest $1,000 you ever made.
While downturns in the stock market are inevitable, if you play the long game, history shows that the stock market has seen a nominal rate of return of 10.9% over the last 50 years. (1) Generally speaking, this means an average return of 10.9% before considering taxes, fees, and inflation. (2)
So what happens if you leave that $10,000 in the stock market for 30 years and receive an average rate of return of 10.9%? You’ll be sitting on $222,816.01. Many new to these concepts have a more conservative take; after all, most of us have lived through recessions. Even at a rate of 5%, your $10,000 will grow to $43,219.42 after 40 years.
In both cases, the growth potential is too great to ignore. The problem comes when people learn this lesson when they’re 55 instead of 25. While these examples speak for themselves, the key takeaway is that putting away money today is how you work smarter, not harder. Time is precious when it comes to compound interest and compound returns.
How Money Can Be a Tool for Both Good and Bad
In the last example, you saw how a relatively small amount of money can be used as a tool to accumulate wealth. You don’t have to be rich to invest $10,000. But coming up with $222,816.01 later in life, if you missed the boat early on, is impossible for many. (3)
Concepts like paying yourself first—where you put away a small amount of your money from each paycheck or every month—are solid principles for leveraging time and accumulating wealth without leaning on luck or hoping for an inheritance.
Apply this idea to maxing out an IRA. Those under 50 can contribute $6,000 per year. Divide that out over 24 paychecks in a year, and you’re looking at $250 in contributions. While it may take a bit of budget finagling to come up with that every paycheck, many will spend that money either way. Using money as a tool, for good, is a choice. Foregoing an auto loan is a perfect way to come up with that money without cutting back on your regular spending.
Speaking of auto loans, debt is an easy way to use money as a tool for the bad. A seemingly little bit of money can get you an awful lot in today’s world. New cars and homes outside our budget are two ways many leverage debt to get things they want instead of prioritizing retirement saving and living within their means.
Remember the compound interest example where you were effortlessly making tens of thousands of dollars over time? The same principle applies here, except this time it’s turned around, and you’re lining someone else’s pocket with money by paying interest instead of receiving it.
How Our Emotions Affect Our Money Habits
Are you a spender or a saver? Many of us naturally lean toward one over the other. But think about these other factors: safety net, social status, helping others, supporting your family, name brand, budget. Each of these will spark emotion and play into how we handle money.
Understanding your emotional ties to money will help you pivot in some areas and learn where you need to make improvements. In the same frame of thought, it can point out strengths and areas where you’re using money as a tool for the good.
Generally speaking, if we are greedy or self-centered by nature, our spending habits often reflect these characteristics. Remaining grounded, thinking about those around us, and prioritizing the future we truly want are great ways to overcome negative emotional ties to money.
Getting it Right With a Financial Planner
With these principles in mind, you’re in the right frame of mind to make sound financial decisions. After all, success with money is often more about discipline and consistency when you’re young rather than mastering complex financial concepts.
When you’re ready to make good decisions, but need a hand in assuring you’re maximizing the dollars you’ve saved, a financial planner can guide you through the planning, savings, and investing strategies required to meet your personalized goals.
This is best done in person so we can get to know you and share our approach firsthand. For a consultation to see if our services can help improve your financial situation, please call 860.434.6890 or email me at richard.stout@bwmllc.net to schedule a consultation.
About Rick
Richard W. Stout III is managing director of Benchmark Wealth Management, LLC, with 25 years of experience in the financial industry. He specializes in financial planning and asset management for individuals, families, and institutions seeking to build and monitor durable and sustainable plans for their financial futures. Rick is a Certified Financial Planner™ professional and holds the Accredited Investment Fiduciary (AIF®) designation. He obtained his MBA from Rensselaer Polytechnic Institute and his BA in Economics and Anthropology from the University of Connecticut. He has earned a Master of Science degree in Personal Financial Planning from the College for Financial Planning. He has extensive background experience in lending, credit review and analysis, and real estate and partnership management. Learn more about Rick by connecting with him on LinkedIn.
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(1) https://www.fool.com/investing/how-to-invest/stocks/average-stock-market-return/
(2) https://www.investopedia.com/terms/n/nominal-rate-of-return.asp
(3) https://www.investor.gov/financial-tools-calculators/calculators/compound-interest-calculator