It's a concept that could work wonders for your finances.
If your goal is to simply find a safe place to keep the money you're socking away for future goals, then you may be inclined to keep your money in a regular old savings account. That way, your principal contributions are protected (up to $250,000 per depositor at an FDIC-insured bank), and you won't see your balance shrink unless you actively take a withdrawal.
But if you'd rather grow your money into a larger sum over time, then investing it is your best bet. And the sooner you start investing, the more wealth you stand to accumulate.
Why so? It's all because of a concept called compounding. And it's something you should aim to take advantage of.
Let your money work for you
Compound interest is the concept of earning interest on interest. Let's say you put $100 into a savings account and that balance grows to $105 by virtue of earning interest. From there, you'll be able to accrue interest on not just your initial $100, but rather, on $105.
It's a concept that can work for you or against you. In the context of credit card debt, interest that compounds against you will cost you money. In the context of savings, it can make you richer. And in the context of investing, it can make you a lot richer.
Now, let's get one thing out of the way. When you buy stocks in a brokerage account and they gain value over time, you're not getting compound interest. Rather, you're getting the option to take advantage of compounded returns, since stocks don't pay interest like bonds and savings accounts do. But all told, compounding could really work to your benefit, especially if you give yourself a long investment window.
In fact, recently, real estate and financial expert Graham Stephan tweeted a quote from Albert Einstein: "Compound interest is the eighth wonder of the world. He who understands it, earns it; he who doesn't, pays it." And you're definitely better off being on the "earns it" side of things.
Compounding can work to your benefit
Let's say you invest $500 a month in a brokerage account over a 20-year period. All told, you're sinking $120,000 into your account, which is a lot of money. But if your investments during that time generate an average annual 8% return, which is below the stock market's average, you'll end up with about $275,000. All told, that's a gain of $155,000. And compounding is what helps make that possible.
But watch what happens if you shrink your investment window to 10 years. You'll end up putting in $60,000 in that case, but you'll only end up with $87,000. That's a $27,000 gain -- not a negligible sum, but not nearly as impressive as a gain of $155,000.
That's why it's in your best interest to start investing from as young an age as possible. Compounding really is a fantastic tool. And the longer you give yourself to benefit from it, the wealthier you stand to become.
