By Laura Roler, Military Saves Associate, AFC® Candidate, FINRA Military Spouse Fellow
Compound interest can work for you or against you. It can provide some amazing benefits, turning a few thousand dollars into a million dollar fund over your lifetime, just in time for a comfortable retirement. However, compound interest is not a concept that only applies to retirement savings. As it applies to debt, it can be a lifelong weight on your finances.
Accumulating a lot of debt early on can detract from your positive financial actions and have serious consequences for your future if you don't work on paying it off. Discover the good, the bad, and the ugly of compound interest, and learn how to make it work for you!
Interest is earned on and then added to the principal. Savings will increase.
Interest charges are accrued and then added to the principal. Debt will increase.
By only making minimum payments on debt, you could be paying on a relatively small debt for years.
Making Compound Interest Work for You
You want your money to work for you in the best, most efficient way possible. To do this, compare interest rates, account balances, and outcomes. By determining the true cost of your debt, you may find paying down $10,000 of high interest debt is a smarter choice than storing the same amount in a low-interest savings account (aside from that emergency fund!). On the other hand, don’t pass up the opportunity to save and earn free money through an employer’s matching retirement plan. It’s an effective way to build savings while eliminating debt. Once your high-interest debts are paid, make compound interest work for you by saving, investing, and accruing interest on your growing balance.
“I know I need to save, but I also have debt.”
Saving and paying off debt are both crucial to achieving financial security; doing both at once can be challenging. Remember that emergency savings is always a top priority to help you manage the unexpected – especially when you are in debt! Your budget, bills, and debt are all likely to suffer if you experience an emergency and have no cash to fall back on. Military Saves encourages everyone to “Start Small. Think Big.” Aim for a $500 to $1000 emergency fund to start if you don’t have one, and grow and replenish it as needed. Most experts recommend a balance of three to six months worth of living expenses for an adequate emergency fund. Once you’ve established at least a $500 fund to cushion your finances in emergencies, it’s time to begin paying down debt.
Timing is everything
The key to compound interest is time. Every year that debt balances grow and retirement saving is delayed is time and money that you will never get back – waiting will cost you! The earlier you address your debt and begin saving, the sooner you will reach your financial goals.