August 27, 2024 • 30 mins
In this episode, we dive into the magic of compound interest and how it can transform your financial future. Rachel and Joshua break down the basics, share real examples, and provide practical tips on how to start investing early. Additionally, special guest Cal Christensen joins the podcast to offer additional insights on the power of compound interest.
View the compound interest calculator discussed in the episode here: https://www.investor.gov/financial-tools-calculators/calculators/compound-interest-calculator
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Episode Transcript
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(00:09):
Welcome to Financially Free Gen Z.
The podcast tailoredspecifically to Gen Zers looking to level
up their financial knowledgeand take control of their money matters.
In each episode, we delve into practicalbudgeting strategies, insightful tips
on debt management, and essential adviceon building a solid financial foundation.
Our goal is to arm you with the knowledgeto own your financial choices
(00:33):
and pave the way for a prosperous future.
Join us as we navigate the world of moneymanagement together.
I'm your host, Rachel Munger.
And I'm your co-host, Joshua Herrmann.
We are both Gen Zers ourselveswho work in the financial industry.
This week we'll be discussingthe power of compound interest.
Yes. So let's start with the basics.
(00:54):
What exactly is compound interest?
In simple terms, it's the interestyou earn on both the money
you save or invest.
And then additionally,the interest that money earns over time.
So it's like a big snowball effect.
Your money starts small,but as it rolls down the hill, it picks up
more and more snow,growing larger and larger.
(01:17):
So to put it into perspective, andthis is a pretty basic way to look at it,
but let's say you invest $1,000at an annual interest rate of 5%.
By the end of thatfirst year, you'd have $1,050.
But here's where the magic happens.
In the second year,you earn interest on that $1,050,
(01:40):
not just your original $1,000.
As long as you're not taking out,that extra $50 that you made.
And so then this processjust keeps repeating and repeating each
year, building on the last. Yeah.
And there are two necessary ingredientsto compound interest time and consistency.
The earlier you start,the more time your money has to grow.
(02:04):
And the amount of time spent in the marketmakes a big difference
when looking at your returns.
A lot of us might thinkwe don't have enough money
to start investing,but that that's a misconception.
Even small investments can growsubstantially thanks to compound interest.
Yeah.
Now, usually one of the first stepsyou're going to be taking in
(02:24):
your investing journey is investingin your company's 401 K or an IRA.
This is something thatwhen I got my first job out of college,
you know, you go and you meet with HR,you do all your onboarding stuff.
And they gave me this big packet,for 401 K's.
And it was a ton of pages.
(02:44):
It didn't mean anything to me.
And I had no idea what I was doing.
So I went and asked my dad, and honestly,he was not that helpful.
So setting up these thingsfor the first time
can be a little bit complicated,because if you never took like,
personal finance or any sort offinancial course, you're not going to
(03:06):
always know what all the wordsmean or what it's asking you.
So I'm going
to talk a little bitmore about that today.
So both 401 K's
and IRAs are tax advantaged accounts,
meaning you're going to get a tax benefitfor using them.
They're both designed to help individualssave for retirement.
(03:28):
And one of the potential benefitsto A 401(k) over an IRA
is sometimes your company will offera match on the money you're investing.
So for example, my 401 K here
at Coulee Bank, they match 4%.
So when I elect to put 4% of my paycheckinto,
(03:48):
my Roth 401 K,Coulee Bank is going to match that number
and put that moneyinto my account as well.
So if your company's offering a match,you'll always want to make sure you're
contributing whateveryou need to get to that full match
if you're able to, because that'sjust free money that's sitting on a table.
Exactly.
I mean, if you think about it,you're investing 8%
(04:11):
in realitybecause you're adding that 4% plus the 4%.
So it's doubling the amount ofmoney that you're investing.
And it's, you know,not just about the amount you invest,
but also about,you know, having having consistent,
consistent investments andhaving the patience to watch those grow.
It's about creating a habit of savingand investing regularly so that over time,
(04:35):
those small, consistent contributions
add up to a larger total.
Now, let's explore how compoundinterest can work for you over
30, 40, and 65 years.
So over 30 years, compoundinterest can transform
modest savings into substantial wealth.
(04:57):
Suppose you invest $10,000
at an annual interest rate of 8%.
With compound interest,your investment will grow each year,
not just by the interest earned,but also by the interest on the interest.
That's how compound interest they
they get you with the interestand the interest on the interest.
So, after 30 years, your initial $10,000
(05:20):
could grow to approximately $100,627.
This demonstrates the exponential growthpotential of compound interest, showing
how a relatively small initial investmentcan yield significant returns with time.
Now, if we extend the time frame
to 40 years, the effects of compoundinterest become even more profound
(05:44):
with the same $10,000 initial investmentand 8% annual interest rate,
your investment would growto approximately $217,245.
This dramatic increase illustrateshow the longer your money is invested,
the more it benefitsfrom the compounding effect.
(06:04):
The additional decadeallows your investment to nearly double
compared to the 30 year scenario,
highlighting the importance of timeand maximizing your returns.
And this is just based off of the $10,000initial investment.
This isn't adding anything else to it.
It's just with the initial investmentand watching it grow over time.
(06:26):
Yeah.
So just with that 40 years,I mean, you're looking at an extra
$200,000 more than that
added from your initial 10,000without you even necessarily
having to do anything except for,you know, being patient and waiting.
It's just kind of crazy. Exactly.
(06:47):
So I've seen a whole bunch of
videos, on TikTok or InstagramReels lately about people
who are able to employ
their children and open IRAs for them.
And I want to start this offby saying I am not a tax professional.
You should always consult a taxprofessional before,
(07:08):
doing something like this.
But you are able to, as a guardian, openan IRA for your child
under 18 years oldif they're making some sort of income.
And so in 2024, the limits are either$7,000 per year can be invested
into that IRA, or however much your childearns per year, whichever is less.
(07:33):
So say your, 14 year old mows
lawns over the summer and makes, $1,000that summer.
You can put $1,000 into an IRAfor your 15 year old,
and that's going to have a ton oftime in the market to grow.
So I've seen people who
(07:54):
will have their kids work,
in, like, baby modeling
or acting as a babyin a TV show or something.
And then they can open IRAs for them, like
literally in the first yearthat they're born.
And now the amount you're payingalways has to be like a legitimate amount.
(08:15):
It's not like I could be like, hey,I took some photos of my kid
and I paid them $7,000,so I'm going to put it in an IRA.
You're asking for troubleif you do something like that.
But any sort of, like, legitimate jobthat you can get for a kid,
you can start an IRA for them.
So I have decided that
(08:37):
whenever I have a child,I need to get them to be the Gerber baby.
Like.
65 yearsin the market is kind of unmatched.
But. So just for illustration sake,just so you can see
how much time in the marketmakes a difference.
If you look at a 65 year investmenthorizon,
(09:01):
compound interest really hasthe opportunity to showcase its potential.
So starting with that same $10,000at an 8% interest rate, what we've talked
about before, your investment over 65
years would turn into $1.4 million.
So $10,000 is all you're putting in.
You're never putting anything else in.
(09:23):
It's going to turn into $1.4 million.
So this extraordinary growthis due to the extended period, allowing
for more frequent compounding cycles,significantly amplifying your returns.
So I think this is a good lesson to,
say you have kids who are in highschool who are working jobs.
(09:43):
As when I was in high school.
I mean, minimum wage was pretty low,so I wasn't making a ton of money,
but I could have had the opportunityto take some of that money
and put it in an IRA.
And I started working at 15.
Typically you're not going to retireto, say, 65, 67.
That money could have sat in an IRAfor 50 years,
(10:06):
which would have majorly,
grown the initial investment.
So these are just some examples.
Obviously every year looks different.
Interestrates aren't set when you're investing.
And so it can vary quite a bit.
But I think it's importantto look at these examples
to know what it really meansto start early.
(10:28):
When it comes to investing.
Well, and also looking at employment.
If you're employedat the same company for,
you know, a set amount of yearsand you get and you get like a pay raise
or somethinglike that, that 4%, like if we took our,
the Coulee Bank example.
Yeah, it that 4% increases.
(10:51):
So it's not a it'slike it's a fixed amount of your income.
But yeah, if you get a pay raisethat 4% goes up too.
So yeah.
That's extremely helpfulwhen you're looking at time
and adding some extra moneyso that you can retire with,
you know, enough to, to surviveuntil the end. Yes.
(11:11):
Sure.
And I will just jump in quickand say there's a compound
interest calculator offered through,
the government. It's a.gov.
So I'm going to link it in the show notes.
But it's fun to just put numbers in therelike an estimated interest rate.
And then it can tell you, what numberyou would be seeing at the end of whatever
(11:32):
period you're looking at.
So I'll link it in the show notes.
But it is kind of fun to play around with.
Indeed.
Now wetalked about the good compound interest,
but now we're going to talk about compoundinterest in regards to debt.
We've seen that compound interest is oftentouted as a powerful tool
(11:53):
for growing your savings,but it can quickly turn
into a formidable adversarywhen it comes to your debt.
Yes. So we're going to hearfrom our special guests soon here.
But starting with credit cards,many people find themselves enticed
by the convenience or immediategratification of a credit card.
However,when you look at the average credit card
(12:16):
interest rate in the US, it'shovering around 16%.
And it can even oftenbe much higher closer to like the 25% APR
mark is what I've been seeingwhen I'm getting ads in the mail.
It's like, right around 25.
So when you're only making the minimumpayment each month, compound interest
starts to work against you, and each monthinterest is added to your balance.
(12:40):
And then the next month you'repaying interest on the new higher balance.
And over time, this can lead to a debtsnowball that's very hard to stop.
Yeah.
I know I have a credit cardthat is sitting at around, like 27, 28%.
Yeah.
And it's, you know, I was looking at,
just doing the minimum payment,and that doesn't cover it.
(13:03):
If I did the minimum payment, it wouldtake me, like 30 years to pay off.
Wow. So that's so crazy.
Yeah.
And instead of trying to invest that $30,you know, that that payment elsewhere.
So. Yeah.
Now, if we take student loansas another example,
many students graduatewith a considerable amount of debt,
(13:26):
which is often necessaryto fund education.
However, the compounding interest onthese loans can make repayment
a daunting task.
If a borrower is unable to make paymentsthat cover the interest
gets capitalized,meaning is added to the principal amount.
This results in even more interestaccruing,
(13:46):
creating a viciouscycle that can span decades.
Yeah.
This is something that,
I know there's some new programsintroduced that are supposed to help
put an end to this,but there's been people who have paid
their student loans for like 15, 20 years,and they still owe
about the same amountas they originally owed because they're
(14:09):
minimum paymentwasn't even covering all of the interest.
And so you can end up owing more,but paying money
all the timeand never making a dent in it.
So it's kind of sad, kind of,
I feel like it's a little bit predatoryof lending because you're meeting
with 18 year olds and they're probably notfully understanding their loan terms.
(14:34):
But you can get intosome pretty crazy situations.
Oh, yeah.
I mean, going going to an 18 yearold and saying,
hey, we can give you $100,000 for school.
Yeah. And, and they're not realizing that.
Well, $100,000, you know, at four
and even even at, like on, on 4.74%.
(14:58):
Yeah.
I thinkis what my federal student loan is at even
that is like,that's $4,700 a year, because on that
you aren't paying towards educationand it's accruing interest.
You know,
some, you know, during your time at schooland some that, after school,
(15:20):
but still $4,700 in interest.
The, it's just a lot.
So, yeah.
Yeah.
And you don't always understandthat when you are
18 and have never maybe had a loan before.
So I do think
places are getting betterabout educating, high schoolers
(15:42):
about what the actual implicationis to your student debt.
But I think we still have a ways to gobefore
we have it kind of figured out. But.
So say you're in this situation,what can be done to mitigate the negative
impacts, the negative impacts of compoundinterest on debt.
(16:03):
So first and foremost,understanding the terms
of your loansand credit agreements is crucial.
Always aim to pay more than the minimumpayment on your credit cards.
To reduce the principal faster andminimize the interest you pay over time.
For studentloans, it's also important to consider
maybe an income drivenrepayment plan that may offer some relief.
(16:26):
Yeah, when you're talking about,
understanding the terms of your loansand credit agreements, it's
I, my my mother, she she gave me
some of the best advice that I could haveis always read the fine print.
She would always read every single wordthat was on,
you know, an agreement or, a planbecause she was like,
(16:50):
if there's something that's going to getme, I'm not going to sign.
And if I don't agree to one thing,I probably shouldn't
agree to the whole thing.
So, yes, I always read the fine print.
Another thing is,you know, financial literacy is key to,
managing your finances.
So educating yourself about interestrates, repayment strategies,
(17:10):
and debt management can empower youto make better financial decisions.
There are numerous resources available,but if you're listening to our podcast.
That's one step in your journey. So yeah.
There's also other,
you can find online courses or,if you go the paid route of like finding
a financial advisor, they can providepersonalized advice as well.
(17:34):
So I think today we've learned compoundinterest can definitely be a double
edged sword.
And it's importantto understand its implications on debt
so that you can help take controlof your financial future.
With us today,we have Cal Christensen, Senior Vice
President and Business BankingOfficer here at Coulee Bank.
(17:55):
Thanks, Cal, for joining us today andsharing your knowledge with our audience.
My pleasure. Nice to be here.
Now, Cal, for someonejust starting their investment journey,
how would you recommend
they harness the power of compoundinterest to build their wealth over time?
And are there specific strategiesor accounts they should consider?
That's a good question, Josh.
(18:15):
You know, compound interest iswhere fortunes are made and lost.
Compound interest of course,is just earning interest on interest
or dividends on dividendsif you're buying stocks and reinvesting.
The premise is real simple.
You know, if you have $1,000 investment
that pays you 10% in a year, it'sworth $1,100.
(18:37):
And if you don't spend the hundred dollars
the next year, you earn 10% intereston that additional $100
as well an additional $10that you had never seen before.
So a good example for someone young is
a simple 10% interest rate return,something like the S&P 500,
(18:58):
which has since it became a 500 stockindex in 1957, has returned.
10.26% in the last 20 years is 9.88.
So that's a big, broad spectrumthat you can buy.
I'm not a financial advisor.
I'm not licensed to sell anything,but that's just a broad 10% return.
(19:18):
So if you're 22 years oldand you invest $600 a month
when you're 65, that will be $3.5million. Ooh.
And now remember to someone
65, $1,000,000 43 years agoseemed like a lot of money.
To someone 22 today, it's not it's a bignumber, but it's not that big of a number.
(19:41):
So keep that into perspective,because the compounding of interest
also is a compounding of inflation,meaning everything you buy,
it's more expensive next year.
So while that seems like a big number,
it may just be an adequate number.
Yeah, yeah, that totally makes sense.
Additionally, compound interest
(20:01):
can be a double edged swordwhen it comes to debt.
Would you be able to elaborateon how it affects
something like credit cardbalances or loans,
and what steps people can take to manageand mitigate that impact?
Absolutely.
The single greatest,
villain in the in the whole interest
(20:21):
compounding world are credit cards.
I took thisright from a credit card company.
I won't say which one,but they're all about the same.
So if you bought something for $4,500,you know, you had a bunch of fun,
you had to do a car repair.It doesn't matter.
But you know them. $4,500and you get your bill
and you've got this magicallysmall amount of $77 as a minimum payment.
(20:44):
So you pay that, and if you continueto pay the minimum payment,
it will take you 14 yearsand you will spend almost $11,000
in interestto pay off that $4,500 balance.
I mean, that's substantial.
Credit cards are the
fastest way to ruin,
(21:05):
now, there's a lot of benefitto credit cards that are not interest
related, and we won't go into all that,but you have to have the discipline
to use them, pay them off,
get your buyer protection becauseyou did it or get your points, whatever.
But if you let that balance roll,it is a slow road to perdition.
Yeah, that's like setting money on fire.
(21:25):
Exactly.
Now, the the even more extremeexample is your mortgage.
You know,if you borrowed $100,000 at a rate
that would be contemporary, right nowthey're changing of about 6.75%.
You will pay over 30 years,
$133,000 in interest.
(21:49):
In just the extreme example,
your first payment is 565
$567, of which only $94 is principal.
Your last payment, $642, is principal.
So you see how it slides through time. Now
the reality is
you need a place to liveso you can pay rent,
(22:10):
or you can have a mortgage, you know,and if you don't like to pay
interest, well, then save your moneyand buy a house for cash.
You're going to be oldby the time this happens.
So some of this is just a reality of life.
You know, how youhow can we do something about that?
There's lots of calculators online.
If you go to Microsoft through Excel,just select a new sheet
(22:31):
and it gives you an optionto pick one of their templates.
And one is an amortization tablewith, with a, accelerated payment.
So you just put in the informationabout your home loan
and how much extrayou want to pay a month,
and you can play with thatand just put in $100,
and you'll be surprisedhow 30 years of payments can become 25
(22:52):
years of payments, and 133,000 becomes
110 or something like that, quite quickly.
Just a little bit of acceleration,
gets you ahead.
But when you're young, you know, early inyour career, this is the most vital time.
And it's also the time you have the leastdisposable cash to put a little extra
(23:12):
in a retirement fund, acceleratea mortgage balance just a little bit.
So these are theyou know, these are the sacrifices
that you make or the opportunitiesthat you can be given.
Yeah.
Yeah.
I just, like a year and a half ago,my husband and I,
we bought our first house,and it's a 30 year mortgage, and we did.
We just went in and we're like,okay, well, if we put this much, this much
(23:36):
extra every month, like, how quicklywould we be able to get it paid off?
And even to make it closerto like a 15 year mortgage,
it is not as huge of a differenceas you would think.
So and then you savelike so much money on interest.
Yeah.
So on you know, put putting an extra
(23:56):
$100 on a, on a paymenttowards a credit card
and it decreases the timethat it takes to pay off.
Substantial. Yeah.
It's something else to point out.
There are some inevitabilities in life.
And one is you'llalways have to pay for a place to live.
You'll always have to pay for food,transportation and clothing.
It's just they won't go away.
(24:17):
No matter what you doto accelerate your mortgage balance.
We give these examples
because we're trying to demonstratethe benefits of compounding and the evils.
Now, depending onwhen you bought your house,
if you would have purchased your homeor refinanced it sometime in 2020 2021,
you very possiblyhave an interest rate under 3%,
(24:39):
which seems crazy because four months agothey were over seven,
which then you have to askyourself, is that $100
better spent paying offa very low interest rate?
Or is it betterspent increasing my retirement savings?
Or my my rainy day retirement or,you know, emergency fund?
So there's there's two ways to look at it.
(25:00):
This this is your greatest your greatestally or your greatest villain.
And I've talked to both of you about this.
And I love thisexample. It's a it's an old one.
It's the
pennydoubling model and the it's a riddle.
Would you ratherI give you $1 million today, or would you
rather I give you the value of a pennydoubled for 30 days
(25:20):
and a penny doubled for 30 days?
It's worth $5,368,000.
But here's how compounding works.
Here's the acceleration.
It takes you seven days for the pennydoubling to get over a dollar in value.
Yeah, it takes you 14 days for that pennyto double to over a hundred.
That's almost half of this time frame.
And you don't get to $1,000 until 17 days.
(25:42):
But by day 30 it's worth over $5 million.
I mean, this is the extreme exampleof 100% compounding daily.
But here's here'sthe velocity that it can move it.
Yeah. Indeed.
Now Cal many of our listenersare just starting to invest?
Can you recount a time when compoundinterest worked to your advantage
(26:04):
in an investment?
Or are there any storiesyou have heard from others
who have used it to their advantage?
And what lessons did you learn fromthat experience?
Well, when you're young, it's oftenwhat lessons didn't you learn?
So sometimes it's a question of reverseengineering your mistakes.
You know, everybody that's 20 ish
has made the mistake ofI'll just charge it.
(26:26):
And suddenlyyou see the effects of compound interest
is that balance doesn't go awayor it takes forever.
Yeah.
You know, I did my best to
put something into a retirement accountearly on in life.
You know, I have examples of friendswho work for their parents at a company.
And that summer job in college,they didn't get any income,
(26:47):
but they were able to contributeto their father's retirement plan
through his business.
Yeah,maybe just a couple of thousand dollars
a year went in as soon as they wereeligible to be in those plans.
So now they have just a couple thousanddollars added, maybe 1 or 2 years
and 35 years later,that's almost $1 million.
Yeah.
(27:07):
You know, it doesn't seem like much,but the younger you are,
any little bit you can put in $50 a month,just $500 a year.
Howeveryou can do it over the course of 40, 45
years can really expand.
Yeah, yeah, it almost seems like to me,as someone who never took
(27:28):
any personal finance or classes like that,it seems like
the secret that I didn't know about.
And then when I finally figured outhow this worked, I was like, wow,
this is kind of my timeto dump stuff in here
if I'm able to,because it's just going to continue
to grow and growuntil I'm at retirement age.
So definitely importantto learn about it early.
(27:49):
If you can.
Well, and you touched on
something very importantthere, you never took any classes.
Most states do not require any kind offinancial literacy course in high schools.
Yeah.
Now Florida has recently passed a law,and there might be a couple other states
that you have to pass this financial literacy law as part of the conditions for.
Yeah, meeting,you know, getting a high school diploma.
(28:10):
And this isn't, you know, auniversity level finance course.
This is basic things.
Then how credit card interest works.
Everything we just talked about here,
how just $500 a year investedwhen you're young, how this works.
And they go into other, more rudimentarythings that just
have never been taught to most people.Yeah.
You know,
and that's kind of a circle way backaround to your question,
(28:32):
Josh, this is how you startis you educate yourself.
You know,everybody tells you from all these
all people tell youto invest your money. Why?
You know, I'll never be old. I'm20 years old.
You can't you can't wrap your arms aroundwhat life's going to be like
for me 45 years from now,and I'm not going to worry about it.
So everybody tells me, invest my money,but they don't tell you.
They don't show the exampleof what happens to that
(28:55):
little bit of investment, a modest amountevery year for all those years.
Cal, thanksso much for sharing your knowledge.
I feel like for me,the biggest thing that always sticks out
is that penny analogy,because it really does showcase
what it can mean to start really earlyfor your investments later on.
(29:17):
Just like the soonest you can startis definitely the best.
Absolutely. You know, I'm glad.
I'm glad to have been on the showwith you guys and
any little bit as soon as you can start
it, put you way down the roadto happiness.
Yeah, and I'm glad that you brought upcredit cards
and trying to avoid them at all costs,because
(29:38):
I'm in a sticky situation right nowand I was able to solve it.
But, you know, charging it in my early 20s
was not not not the sourceof what I should have been doing.
So it'll get you.
Oh yeah. Absolutely they will. So,
well, I just
want to say a bigthanks to our special guest, Cal,
(29:58):
for sitting down with usto discuss the power of compound interest.
And thank you so much to our audiencefor joining us.
We encourage you to follow our podcast,wherever you are streaming,
so that you can be the firstto see when a new episode drops.
We look forward to talking with you againnext month.
Thanks for listening.
This episode is brought to youby Coulee Bank, a member of FDIC.
Welcome to Financially Free Gen Z.
The podcast tailoredspecifically to Gen Zers looking to level
up their financial knowledgeand take control of their money matters.
In each episode, we delve into practicalbudgeting strategies, insightful tips
on debt management, and essential adviceon building a solid financial foundation.
Our goal is to arm you with the knowledgeto own your financial choices
(00:33):
and pave the way for a prosperous future.
Join us as we navigate the world of moneymanagement together.
I'm your host, Rachel Munger.
And I'm your co-host, Joshua Herrmann.
We are both Gen Zers ourselveswho work in the financial industry.
This week we'll be discussingthe power of compound interest.
Yes. So let's start with the basics.
(00:54):
What exactly is compound interest?
In simple terms, it's the interestyou earn on both the money
you save or invest.
And then additionally,the interest that money earns over time.
So it's like a big snowball effect.
Your money starts small,but as it rolls down the hill, it picks up
more and more snow,growing larger and larger.
(01:17):
So to put it into perspective, andthis is a pretty basic way to look at it,
but let's say you invest $1,000at an annual interest rate of 5%.
By the end of thatfirst year, you'd have $1,050.
But here's where the magic happens.
In the second year,you earn interest on that $1,050,
(01:40):
not just your original $1,000.
As long as you're not taking out,that extra $50 that you made.
And so then this processjust keeps repeating and repeating each
year, building on the last. Yeah.
And there are two necessary ingredientsto compound interest time and consistency.
The earlier you start,the more time your money has to grow.
(02:04):
And the amount of time spent in the marketmakes a big difference
when looking at your returns.
A lot of us might thinkwe don't have enough money
to start investing,but that that's a misconception.
Even small investments can growsubstantially thanks to compound interest.
Yeah.
Now, usually one of the first stepsyou're going to be taking in
(02:24):
your investing journey is investingin your company's 401 K or an IRA.
This is something thatwhen I got my first job out of college,
you know, you go and you meet with HR,you do all your onboarding stuff.
And they gave me this big packet,for 401 K's.
And it was a ton of pages.
(02:44):
It didn't mean anything to me.
And I had no idea what I was doing.
So I went and asked my dad, and honestly,he was not that helpful.
So setting up these thingsfor the first time
can be a little bit complicated,because if you never took like,
personal finance or any sort offinancial course, you're not going to
(03:06):
always know what all the wordsmean or what it's asking you.
So I'm going
to talk a little bitmore about that today.
So both 401 K's
and IRAs are tax advantaged accounts,
meaning you're going to get a tax benefitfor using them.
They're both designed to help individualssave for retirement.
(03:28):
And one of the potential benefitsto A 401(k) over an IRA
is sometimes your company will offera match on the money you're investing.
So for example, my 401 K here
at Coulee Bank, they match 4%.
So when I elect to put 4% of my paycheckinto,
(03:48):
my Roth 401 K,Coulee Bank is going to match that number
and put that moneyinto my account as well.
So if your company's offering a match,you'll always want to make sure you're
contributing whateveryou need to get to that full match
if you're able to, because that'sjust free money that's sitting on a table.
Exactly.
I mean, if you think about it,you're investing 8%
(04:11):
in realitybecause you're adding that 4% plus the 4%.
So it's doubling the amount ofmoney that you're investing.
And it's, you know,not just about the amount you invest,
but also about,you know, having having consistent,
consistent investments andhaving the patience to watch those grow.
It's about creating a habit of savingand investing regularly so that over time,
(04:35):
those small, consistent contributions
add up to a larger total.
Now, let's explore how compoundinterest can work for you over
30, 40, and 65 years.
So over 30 years, compoundinterest can transform
modest savings into substantial wealth.
(04:57):
Suppose you invest $10,000
at an annual interest rate of 8%.
With compound interest,your investment will grow each year,
not just by the interest earned,but also by the interest on the interest.
That's how compound interest they
they get you with the interestand the interest on the interest.
So, after 30 years, your initial $10,000
(05:20):
could grow to approximately $100,627.
This demonstrates the exponential growthpotential of compound interest, showing
how a relatively small initial investmentcan yield significant returns with time.
Now, if we extend the time frame
to 40 years, the effects of compoundinterest become even more profound
(05:44):
with the same $10,000 initial investmentand 8% annual interest rate,
your investment would growto approximately $217,245.
This dramatic increase illustrateshow the longer your money is invested,
the more it benefitsfrom the compounding effect.
(06:04):
The additional decadeallows your investment to nearly double
compared to the 30 year scenario,
highlighting the importance of timeand maximizing your returns.
And this is just based off of the $10,000initial investment.
This isn't adding anything else to it.
It's just with the initial investmentand watching it grow over time.
(06:26):
Yeah.
So just with that 40 years,I mean, you're looking at an extra
$200,000 more than that
added from your initial 10,000without you even necessarily
having to do anything except for,you know, being patient and waiting.
It's just kind of crazy. Exactly.
(06:47):
So I've seen a whole bunch of
videos, on TikTok or InstagramReels lately about people
who are able to employ
their children and open IRAs for them.
And I want to start this offby saying I am not a tax professional.
You should always consult a taxprofessional before,
(07:08):
doing something like this.
But you are able to, as a guardian, openan IRA for your child
under 18 years oldif they're making some sort of income.
And so in 2024, the limits are either$7,000 per year can be invested
into that IRA, or however much your childearns per year, whichever is less.
(07:33):
So say your, 14 year old mows
lawns over the summer and makes, $1,000that summer.
You can put $1,000 into an IRAfor your 15 year old,
and that's going to have a ton oftime in the market to grow.
So I've seen people who
(07:54):
will have their kids work,
in, like, baby modeling
or acting as a babyin a TV show or something.
And then they can open IRAs for them, like
literally in the first yearthat they're born.
And now the amount you're payingalways has to be like a legitimate amount.
(08:15):
It's not like I could be like, hey,I took some photos of my kid
and I paid them $7,000,so I'm going to put it in an IRA.
You're asking for troubleif you do something like that.
But any sort of, like, legitimate jobthat you can get for a kid,
you can start an IRA for them.
So I have decided that
(08:37):
whenever I have a child,I need to get them to be the Gerber baby.
Like.
65 yearsin the market is kind of unmatched.
But. So just for illustration sake,just so you can see
how much time in the marketmakes a difference.
If you look at a 65 year investmenthorizon,
(09:01):
compound interest really hasthe opportunity to showcase its potential.
So starting with that same $10,000at an 8% interest rate, what we've talked
about before, your investment over 65
years would turn into $1.4 million.
So $10,000 is all you're putting in.
You're never putting anything else in.
(09:23):
It's going to turn into $1.4 million.
So this extraordinary growthis due to the extended period, allowing
for more frequent compounding cycles,significantly amplifying your returns.
So I think this is a good lesson to,
say you have kids who are in highschool who are working jobs.
(09:43):
As when I was in high school.
I mean, minimum wage was pretty low,so I wasn't making a ton of money,
but I could have had the opportunityto take some of that money
and put it in an IRA.
And I started working at 15.
Typically you're not going to retireto, say, 65, 67.
That money could have sat in an IRAfor 50 years,
(10:06):
which would have majorly,
grown the initial investment.
So these are just some examples.
Obviously every year looks different.
Interestrates aren't set when you're investing.
And so it can vary quite a bit.
But I think it's importantto look at these examples
to know what it really meansto start early.
(10:28):
When it comes to investing.
Well, and also looking at employment.
If you're employedat the same company for,
you know, a set amount of yearsand you get and you get like a pay raise
or somethinglike that, that 4%, like if we took our,
the Coulee Bank example.
Yeah, it that 4% increases.
(10:51):
So it's not a it'slike it's a fixed amount of your income.
But yeah, if you get a pay raisethat 4% goes up too.
So yeah.
That's extremely helpfulwhen you're looking at time
and adding some extra moneyso that you can retire with,
you know, enough to, to surviveuntil the end. Yes.
(11:11):
Sure.
And I will just jump in quickand say there's a compound
interest calculator offered through,
the government. It's a.gov.
So I'm going to link it in the show notes.
But it's fun to just put numbers in therelike an estimated interest rate.
And then it can tell you, what numberyou would be seeing at the end of whatever
(11:32):
period you're looking at.
So I'll link it in the show notes.
But it is kind of fun to play around with.
Indeed.
Now wetalked about the good compound interest,
but now we're going to talk about compoundinterest in regards to debt.
We've seen that compound interest is oftentouted as a powerful tool
(11:53):
for growing your savings,but it can quickly turn
into a formidable adversarywhen it comes to your debt.
Yes. So we're going to hearfrom our special guests soon here.
But starting with credit cards,many people find themselves enticed
by the convenience or immediategratification of a credit card.
However,when you look at the average credit card
(12:16):
interest rate in the US, it'shovering around 16%.
And it can even oftenbe much higher closer to like the 25% APR
mark is what I've been seeingwhen I'm getting ads in the mail.
It's like, right around 25.
So when you're only making the minimumpayment each month, compound interest
starts to work against you, and each monthinterest is added to your balance.
(12:40):
And then the next month you'repaying interest on the new higher balance.
And over time, this can lead to a debtsnowball that's very hard to stop.
Yeah.
I know I have a credit cardthat is sitting at around, like 27, 28%.
Yeah.
And it's, you know, I was looking at,
just doing the minimum payment,and that doesn't cover it.
(13:03):
If I did the minimum payment, it wouldtake me, like 30 years to pay off.
Wow. So that's so crazy.
Yeah.
And instead of trying to invest that $30,you know, that that payment elsewhere.
So. Yeah.
Now, if we take student loansas another example,
many students graduatewith a considerable amount of debt,
(13:26):
which is often necessaryto fund education.
However, the compounding interest onthese loans can make repayment
a daunting task.
If a borrower is unable to make paymentsthat cover the interest
gets capitalized,meaning is added to the principal amount.
This results in even more interestaccruing,
(13:46):
creating a viciouscycle that can span decades.
Yeah.
This is something that,
I know there's some new programsintroduced that are supposed to help
put an end to this,but there's been people who have paid
their student loans for like 15, 20 years,and they still owe
about the same amountas they originally owed because they're
(14:09):
minimum paymentwasn't even covering all of the interest.
And so you can end up owing more,but paying money
all the timeand never making a dent in it.
So it's kind of sad, kind of,
I feel like it's a little bit predatoryof lending because you're meeting
with 18 year olds and they're probably notfully understanding their loan terms.
(14:34):
But you can get intosome pretty crazy situations.
Oh, yeah.
I mean, going going to an 18 yearold and saying,
hey, we can give you $100,000 for school.
Yeah. And, and they're not realizing that.
Well, $100,000, you know, at four
and even even at, like on, on 4.74%.
(14:58):
Yeah.
I thinkis what my federal student loan is at even
that is like,that's $4,700 a year, because on that
you aren't paying towards educationand it's accruing interest.
You know,
some, you know, during your time at schooland some that, after school,
(15:20):
but still $4,700 in interest.
The, it's just a lot.
So, yeah.
Yeah.
And you don't always understandthat when you are
18 and have never maybe had a loan before.
So I do think
places are getting betterabout educating, high schoolers
(15:42):
about what the actual implicationis to your student debt.
But I think we still have a ways to gobefore
we have it kind of figured out. But.
So say you're in this situation,what can be done to mitigate the negative
impacts, the negative impacts of compoundinterest on debt.
(16:03):
So first and foremost,understanding the terms
of your loansand credit agreements is crucial.
Always aim to pay more than the minimumpayment on your credit cards.
To reduce the principal faster andminimize the interest you pay over time.
For studentloans, it's also important to consider
maybe an income drivenrepayment plan that may offer some relief.
(16:26):
Yeah, when you're talking about,
understanding the terms of your loansand credit agreements, it's
I, my my mother, she she gave me
some of the best advice that I could haveis always read the fine print.
She would always read every single wordthat was on,
you know, an agreement or, a planbecause she was like,
(16:50):
if there's something that's going to getme, I'm not going to sign.
And if I don't agree to one thing,I probably shouldn't
agree to the whole thing.
So, yes, I always read the fine print.
Another thing is,you know, financial literacy is key to,
managing your finances.
So educating yourself about interestrates, repayment strategies,
(17:10):
and debt management can empower youto make better financial decisions.
There are numerous resources available,but if you're listening to our podcast.
That's one step in your journey. So yeah.
There's also other,
you can find online courses or,if you go the paid route of like finding
a financial advisor, they can providepersonalized advice as well.
(17:34):
So I think today we've learned compoundinterest can definitely be a double
edged sword.
And it's importantto understand its implications on debt
so that you can help take controlof your financial future.
With us today,we have Cal Christensen, Senior Vice
President and Business BankingOfficer here at Coulee Bank.
(17:55):
Thanks, Cal, for joining us today andsharing your knowledge with our audience.
My pleasure. Nice to be here.
Now, Cal, for someonejust starting their investment journey,
how would you recommend
they harness the power of compoundinterest to build their wealth over time?
And are there specific strategiesor accounts they should consider?
That's a good question, Josh.
(18:15):
You know, compound interest iswhere fortunes are made and lost.
Compound interest of course,is just earning interest on interest
or dividends on dividendsif you're buying stocks and reinvesting.
The premise is real simple.
You know, if you have $1,000 investment
that pays you 10% in a year, it'sworth $1,100.
(18:37):
And if you don't spend the hundred dollars
the next year, you earn 10% intereston that additional $100
as well an additional $10that you had never seen before.
So a good example for someone young is
a simple 10% interest rate return,something like the S&P 500,
(18:58):
which has since it became a 500 stockindex in 1957, has returned.
10.26% in the last 20 years is 9.88.
So that's a big, broad spectrumthat you can buy.
I'm not a financial advisor.
I'm not licensed to sell anything,but that's just a broad 10% return.
(19:18):
So if you're 22 years oldand you invest $600 a month
when you're 65, that will be $3.5million. Ooh.
And now remember to someone
65, $1,000,000 43 years agoseemed like a lot of money.
To someone 22 today, it's not it's a bignumber, but it's not that big of a number.
(19:41):
So keep that into perspective,because the compounding of interest
also is a compounding of inflation,meaning everything you buy,
it's more expensive next year.
So while that seems like a big number,
it may just be an adequate number.
Yeah, yeah, that totally makes sense.
Additionally, compound interest
(20:01):
can be a double edged swordwhen it comes to debt.
Would you be able to elaborateon how it affects
something like credit cardbalances or loans,
and what steps people can take to manageand mitigate that impact?
Absolutely.
The single greatest,
villain in the in the whole interest
(20:21):
compounding world are credit cards.
I took thisright from a credit card company.
I won't say which one,but they're all about the same.
So if you bought something for $4,500,you know, you had a bunch of fun,
you had to do a car repair.It doesn't matter.
But you know them. $4,500and you get your bill
and you've got this magicallysmall amount of $77 as a minimum payment.
(20:44):
So you pay that, and if you continueto pay the minimum payment,
it will take you 14 yearsand you will spend almost $11,000
in interestto pay off that $4,500 balance.
I mean, that's substantial.
Credit cards are the
fastest way to ruin,
(21:05):
now, there's a lot of benefitto credit cards that are not interest
related, and we won't go into all that,but you have to have the discipline
to use them, pay them off,
get your buyer protection becauseyou did it or get your points, whatever.
But if you let that balance roll,it is a slow road to perdition.
Yeah, that's like setting money on fire.
(21:25):
Exactly.
Now, the the even more extremeexample is your mortgage.
You know,if you borrowed $100,000 at a rate
that would be contemporary, right nowthey're changing of about 6.75%.
You will pay over 30 years,
$133,000 in interest.
(21:49):
In just the extreme example,
your first payment is 565
$567, of which only $94 is principal.
Your last payment, $642, is principal.
So you see how it slides through time. Now
the reality is
you need a place to liveso you can pay rent,
(22:10):
or you can have a mortgage, you know,and if you don't like to pay
interest, well, then save your moneyand buy a house for cash.
You're going to be oldby the time this happens.
So some of this is just a reality of life.
You know, how youhow can we do something about that?
There's lots of calculators online.
If you go to Microsoft through Excel,just select a new sheet
(22:31):
and it gives you an optionto pick one of their templates.
And one is an amortization tablewith, with a, accelerated payment.
So you just put in the informationabout your home loan
and how much extrayou want to pay a month,
and you can play with thatand just put in $100,
and you'll be surprisedhow 30 years of payments can become 25
(22:52):
years of payments, and 133,000 becomes
110 or something like that, quite quickly.
Just a little bit of acceleration,
gets you ahead.
But when you're young, you know, early inyour career, this is the most vital time.
And it's also the time you have the leastdisposable cash to put a little extra
(23:12):
in a retirement fund, acceleratea mortgage balance just a little bit.
So these are theyou know, these are the sacrifices
that you make or the opportunitiesthat you can be given.
Yeah.
Yeah.
I just, like a year and a half ago,my husband and I,
we bought our first house,and it's a 30 year mortgage, and we did.
We just went in and we're like,okay, well, if we put this much, this much
(23:36):
extra every month, like, how quicklywould we be able to get it paid off?
And even to make it closerto like a 15 year mortgage,
it is not as huge of a differenceas you would think.
So and then you savelike so much money on interest.
Yeah.
So on you know, put putting an extra
(23:56):
$100 on a, on a paymenttowards a credit card
and it decreases the timethat it takes to pay off.
Substantial. Yeah.
It's something else to point out.
There are some inevitabilities in life.
And one is you'llalways have to pay for a place to live.
You'll always have to pay for food,transportation and clothing.
It's just they won't go away.
(24:17):
No matter what you doto accelerate your mortgage balance.
We give these examples
because we're trying to demonstratethe benefits of compounding and the evils.
Now, depending onwhen you bought your house,
if you would have purchased your homeor refinanced it sometime in 2020 2021,
you very possiblyhave an interest rate under 3%,
(24:39):
which seems crazy because four months agothey were over seven,
which then you have to askyourself, is that $100
better spent paying offa very low interest rate?
Or is it betterspent increasing my retirement savings?
Or my my rainy day retirement or,you know, emergency fund?
So there's there's two ways to look at it.
(25:00):
This this is your greatest your greatestally or your greatest villain.
And I've talked to both of you about this.
And I love thisexample. It's a it's an old one.
It's the
pennydoubling model and the it's a riddle.
Would you ratherI give you $1 million today, or would you
rather I give you the value of a pennydoubled for 30 days
(25:20):
and a penny doubled for 30 days?
It's worth $5,368,000.
But here's how compounding works.
Here's the acceleration.
It takes you seven days for the pennydoubling to get over a dollar in value.
Yeah, it takes you 14 days for that pennyto double to over a hundred.
That's almost half of this time frame.
And you don't get to $1,000 until 17 days.
(25:42):
But by day 30 it's worth over $5 million.
I mean, this is the extreme exampleof 100% compounding daily.
But here's here'sthe velocity that it can move it.
Yeah. Indeed.
Now Cal many of our listenersare just starting to invest?
Can you recount a time when compoundinterest worked to your advantage
(26:04):
in an investment?
Or are there any storiesyou have heard from others
who have used it to their advantage?
And what lessons did you learn fromthat experience?
Well, when you're young, it's oftenwhat lessons didn't you learn?
So sometimes it's a question of reverseengineering your mistakes.
You know, everybody that's 20 ish
has made the mistake ofI'll just charge it.
(26:26):
And suddenlyyou see the effects of compound interest
is that balance doesn't go awayor it takes forever.
Yeah.
You know, I did my best to
put something into a retirement accountearly on in life.
You know, I have examples of friendswho work for their parents at a company.
And that summer job in college,they didn't get any income,
(26:47):
but they were able to contributeto their father's retirement plan
through his business.
Yeah,maybe just a couple of thousand dollars
a year went in as soon as they wereeligible to be in those plans.
So now they have just a couple thousanddollars added, maybe 1 or 2 years
and 35 years later,that's almost $1 million.
Yeah.
(27:07):
You know, it doesn't seem like much,but the younger you are,
any little bit you can put in $50 a month,just $500 a year.
Howeveryou can do it over the course of 40, 45
years can really expand.
Yeah, yeah, it almost seems like to me,as someone who never took
(27:28):
any personal finance or classes like that,it seems like
the secret that I didn't know about.
And then when I finally figured outhow this worked, I was like, wow,
this is kind of my timeto dump stuff in here
if I'm able to,because it's just going to continue
to grow and growuntil I'm at retirement age.
So definitely importantto learn about it early.
(27:49):
If you can.
Well, and you touched on
something very importantthere, you never took any classes.
Most states do not require any kind offinancial literacy course in high schools.
Yeah.
Now Florida has recently passed a law,and there might be a couple other states
that you have to pass this financial literacy law as part of the conditions for.
Yeah, meeting,you know, getting a high school diploma.
(28:10):
And this isn't, you know, auniversity level finance course.
This is basic things.
Then how credit card interest works.
Everything we just talked about here,
how just $500 a year investedwhen you're young, how this works.
And they go into other, more rudimentarythings that just
have never been taught to most people.Yeah.
You know,
and that's kind of a circle way backaround to your question,
(28:32):
Josh, this is how you startis you educate yourself.
You know,everybody tells you from all these
all people tell youto invest your money. Why?
You know, I'll never be old. I'm20 years old.
You can't you can't wrap your arms aroundwhat life's going to be like
for me 45 years from now,and I'm not going to worry about it.
So everybody tells me, invest my money,but they don't tell you.
They don't show the exampleof what happens to that
(28:55):
little bit of investment, a modest amountevery year for all those years.
Cal, thanksso much for sharing your knowledge.
I feel like for me,the biggest thing that always sticks out
is that penny analogy,because it really does showcase
what it can mean to start really earlyfor your investments later on.
(29:17):
Just like the soonest you can startis definitely the best.
Absolutely. You know, I'm glad.
I'm glad to have been on the showwith you guys and
any little bit as soon as you can start
it, put you way down the roadto happiness.
Yeah, and I'm glad that you brought upcredit cards
and trying to avoid them at all costs,because
(29:38):
I'm in a sticky situation right nowand I was able to solve it.
But, you know, charging it in my early 20s
was not not not the sourceof what I should have been doing.
So it'll get you.
Oh yeah. Absolutely they will. So,
well, I just
want to say a bigthanks to our special guest, Cal,
(29:58):
for sitting down with usto discuss the power of compound interest.
And thank you so much to our audiencefor joining us.
We encourage you to follow our podcast,wherever you are streaming,
so that you can be the firstto see when a new episode drops.
We look forward to talking with you againnext month.
Thanks for listening.
This episode is brought to youby Coulee Bank, a member of FDIC.
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