Anyone who has a reasonable knowledge of arithmetic formulas can grasp the concept of compound interest; it is not difficult to understand, but its simplicity belies how powerful it can be in terms of personal finance. Some people derisively refer to compound interest as a method used by “old money” families to increase their aristocratic wealth, but it should be noted that anyone can take advantage of this investment strategy.
Three Steps to Making Compound Interests a Habit
To get into compounding, the first step should involve a review of your personal finances. Preferably, you should be sticking to a budget and building up an emergency cash reserve worth three months of household expenses, including mortgage payments or rent, utilities, food, personal hygiene items, and medications. You can actually get started with compound interest without a budget or emergency cash; however, these two items make it easier for you to foster financial discipline.
The next step is to choose the financial instruments that will ground your compounding portfolio. Keeping in mind that compound interest strategies demand a long-term commitment, selecting a high-yield savings account could be a good move because of its easy deposit options. In November 2020, for example, Ally Bank offered a savings account that compounds daily with an annual percentage yield of 0.60%, and the interest paid monthly. You can also choose certificates of deposit, bonds, and even retirement accounts as long as they offer compound interest as a feature.
Your portfolio should not be static; it will need to grow
The third and final step needs to be recurring in order to put your financial plan into action. Your portfolio should not be static; it will need to grow, and one of the best ways to accomplish this is to make a deposit commitment each and every month. It does not matter if you can only make a $5 monthly deposit for the time being. What is important is that you make this minimum deposit a hard habit to break. An even better strategy would be to challenge yourself with higher deposits. If you deposit $5 in November, $7 and December, and $10 in January, you should try to deposit at least $11 in February.