Guest Author - Reshma Vyas
The pathetically low yields on savings accounts are hardly an encouraging motivation to save money. From a psychological perspective, earning 0.50% to 1% on your savings seems like a sheer waste of time and effort. Why bother to save? But this is an overly pessimistic and somewhat defeatist attitude to take. Let us look at a two "real-life" scenarios and see what they can tell us:
Scenario 1. Start with a $1000 balance in a savings account which earns 0.50% compounded annually. You deposit $250 every month. After 5 years, you would end up with approximately $16,210, rounded to the nearest dollar. Of course, you put in $16,000 of your money which generated about $210 in earnings. While you may have earned nearly "nothing" in terms of interest income, you did not lose any money, either. What is particularly noteworthy is that the growth of this money was disproportionately due to your savings efforts!
Scenario 2. You deposit $1000 in a savings account and will deposit $325 a month for 5 years. The account earns 1% compounded annually. After 5 years, your account balance would be roughly $21,035, rounded to the nearest dollar. Notice that you put in $20,500 which generated approximately $535 earnings in interest income. While $535 is a pitifully low amount, it is also an entirely risk-free gain!
What Do These Scenarios Tell Us?
Well, for one thing, we can quickly surmise that consistency is the driver for this truly remarkable growth of money over the 5 year period. So, the real financial miracle in this context is not the power of compounding interest but the miracle of being able to save $250 or $325 on a consistent basis, month after month. You do not have to start with a "huge" balance in order to make money. In fact, even if you began with a $1000 balance, deposited $150 every month for 5 years and earned only 0.50% on the account, you would still end up with a balance of slightly more than $10,136! Nearly all, except for the $136 or so, would be "your money." That is quite an achievement! Ultimately, we can still accumulate a significant amount of money if we create a savings plan and stick to it persistently, regardless of how many outside interruptions or obstacles we may have to contend with that are beyond our control.