Dr. Nicholas E. Michels, CFP®
There is a rumor that Albert Einstein once commented on the principle of compounding interest as the most potent force in the universe. But is it a good investment strategy? The answer is generally yes, as anyone can benefit from investing in an account with compounding interest. Even short-term investments can accumulate significant earnings from this financial strategy.
Compound interest is understood by recognizing the time value of money, which means that a dollar today is more valuable than it will be in the future. Savvy investors utilize this principle and exercise patience to grow their wealth and pursue long-term financial stability.
Our team at Michels Family Financial knows that there are many unanswered questions surrounding this topic. Below is a quick outline we’ve created to guide you to the answers around compound interest and how it can impact your portfolio.
What Is Compound Interest?
Compound interest means that an investor will earn interest on both the initial investment and all the interest the investor gains from his or her investment. This amount can multiply at an accelerating rate and create much more money than the original amount invested. So, how exactly does it work?
If you take $1,000 and invest it in an account that earns compound interest at a rate of 10%, then your initial investment increases to $1,100. You then make 10% interest on $1,100, increasing the amount to $1,210.
The compounding of interest can continue indefinitely, and eventually, you will have earned a sum far greater than the initial investment amount of $1,000. Clearly, this strategy is beneficial for all investors who want to maximize their investment and make their money work for them.
Key Factors to Consider
There are several key elements of compound interest that will make a difference in the amount you gain from the initial investment. A higher interest rate will create larger returns in the long run, but as tempting as the higher rate of return may be, remember that, in general, the higher the interest rate, the riskier the investment. For instance, small-cap stocks tend to produce higher returns than large-cap stocks. Though you have the potential to earn more, you also have a much greater potential to lose.
Time and patience are absolutely critical when engaging in this investment strategy. The longer you leave your money invested, the more wealth you will generate. If you are starting late, that’s okay. Keeping money invested in an account with compounding interest in the years leading up to retirement can still yield excellent results and will be a helpful source of income in retirement.
Another key element to consider is the frequency at which the amount is compounded. Some accounts allow for the investment to be compounded daily or monthly, while other investments compound annually. The more frequent the compounding is, the more money you will gain.
The tax rate is another consideration. Typically, you will have to pay taxes on the interest earned, but those taxes can be delayed if the investment is made in a retirement account, such as a traditional IRA, Roth IRA 401(k), or SEP-IRA.
Tools and Support to Help
If this sounds like something you’re interested in but you still have questions, don’t worry. There are many resources online to help you, like the U.S. Securities and Exchange Commission Compound Interest Calculator, which takes into account the compounding frequency, length of the investment period, and the interest rate to calculate how much your investment could be worth over a certain amount of time.
But if you still have questions and want to know how to strategically implement compounding interest into your investment plan, consulting with a wealth advisor may be the next best step. At Michels Family Financial, our mission is to support our clients with objective advice consistent with their values so they can live life to the fullest. We would love to meet with you to discuss your goals and how you can put compounding interest to work for you. Reach out to me at [email protected] to get started today!
About Nick
As the founder, CERTIFIED FINANCIAL PLANNER™ professional, and National Social Security Advisor at Michels Family Financial, a financial firm founded on principles. Dr. Nicholas E. Michels spends his days helping clients find financial confidence, clarity, and results they desire. With 15 years of experience, Nick is passionate about helping others create a better life for themselves and their families, ensuring that their money is a blessing, not a stress-ridden curse. Nick prioritizes financial education, empowering his clients with the knowledge that will help them achieve financial security, peace, and happiness. Nick strives to build long-lasting relationships so he can design comprehensive financial plans that help them live out their dreams, using his proven Complete Wealth Management process.
As an accomplished basketball player, Nick became a two-time first-team All-American and Academic All-American basketball player at Dallas Baptist University and was DBU’s 2008 Male Athlete of the Year. This opened the door for him to spend many years traveling the world with Athletes in Action. Not only was this an amazing experience, but it also taught him a lot about pursuing something with passion and finding different ways to help and serve others. His athletic background helped lead him to this career because it gave him the confidence and ability to clarify needs and help his clients succeed.
Outside of work, you can find Nick staying active and spending time with his wife, Chelsea, and their three children, Daegen, Kinsley, and Nicholas Brooks. To learn more about Nick, connect with him on LinkedIn.