Slide 1: The Magic of Compounding: Making Your Money Work Harder

In lesson 1, we laid the groundwork for understanding the importance of saving for your future, and we discovered that **time** is, without a doubt, your most valuable asset when it comes to retirement planning. Think about it – the longer you have until retirement, the more opportunity your money has to grow. Today, we're going to examine the engine that drives that growth over time. We're going to unlock the secrets of a powerful financial concept called *compounding*. Get ready to see how your money can truly work harder for you. 

Slide 2: Recap: Why Start Early?

The more time you give your money to grow, the more significant the eventual outcome. Imagine planting two identical seeds. One you plant today, and the other you wait ten years to plant. Which one do you think will be larger and stronger after twenty years? The same principle applies to your savings. But the question remains: how does this large growth happen? What's the process that allows your money to increase, seemingly on its own? That's where the magic of *compounding* comes in. 

Slide 3: Simple Interest vs. Compound Interest With 

SIMPLE Interest is when you earn interest only on the original amount. 

Compound Interest is when you earn interest on the original amount PLUS the interest you've already earned. 

Think of simple interest as earning a fixed amount of interest each year, based solely on your initial deposit, or **principal**. 

Let's illustrate with a simple example. Imagine you invest $100 in a savings bond that pays 5% simple interest per year. In the first year, you'd earn 5% of $100, which is $5. So, after one year, you'd have $105. In the second year, you'd again earn 5% of the *original* $100, another $5, bringing your total to $110. This continues year after year – you earn the same $5 in interest each time. 

Now, let's contrast this with **compound interest**. With compounding, you also earn interest on your initial $100 in the first year, giving you $105. But here's the  difference: in the *second* year, you don't just earn interest on the original $100. Instead, you earn interest on the *new, larger amount* of $105. So, 5% of $105 is $5.25. This means at the end of the second year, you'd have $105 + $5.25 = $110.25. 

Over time this will make a big difference in saving.  Imagine the exciting growth potential over the long term, especially as you continue to invest yearly. 

Slide 4: Compounding growth 

This chart illustrates the growth potential. In addition to an initial investment of $1,000, there is a monthly contribution of $60. Compounding interest on these investments results in substantial growth, reaching $54,403. 

Slide 5: Compound Interest: Interest Earning Interest 

With your investments and compound interest, the interest you earn in one period becomes part of your new, larger balance. In the next period, you earn interest not only on your original investment but also on that previously earned interest. This cycle repeats, over and over. Over time, your money grows at an accelerating rate. It's a powerful engine for wealth creation! 

Slide 6: The Compounding Advantage: Starting Early 

This slide clearly shows the incredible benefit of starting your investment journey early and embracing the power of compounding. Consider two hypothetical savers earning a 7% return: the first begins saving $6,000 each year at age 25 and continues until age 67, ending up with over $400,000 more than the second, who starts just five years later at age 30. This is a compelling example of how those early years can truly make a large difference!" 

Slide 7: The Rule of 72: Doubling Your Money 

Now, let's explore a handy little shortcut that can help you quickly grasp the power of compounding and the impact of different rates of return. It's called the **Rule of 72**. 

This rule provides a simple way to estimate how many years it will take for your investment to double in value.

The formula is straightforward: you take the number 72 and divide it by the annual interest rate. 

The result is an estimated number of years it will take for your initial investment to double. 

This rule is a useful tool for understanding the long-term implications of different investment returns. 

Slide 8: Using the Rule of 72 (Examples) 

Let's put the Rule of 72 into practice with a few  examples: 

Example 1: At a 4% annual rate of return: Using the formula, 72 divided by 4 equals 18. This suggests that if your investment earns an average of 4% per year, it would take about 18 years for your initial investment to double in value. 

 Example 2: At a 6% annual rate of return: Applying the rule, your money could potentially double in about 12 years. 

Notice how a relatively small increase in the rate of return significantly reduces the doubling time. 

Example 3:  If your investment earns an average of 8% per year, 72 divided by 8 equals 9. 

In this scenario, your initial investment could potentially double in roughly 9 years. 

This shows how a modest improvement in your investment returns can have a substantial impact on your long-term wealth accumulation thanks to the power of compounding. 

Slide 9: The Impact of Fees and Withdrawals 

While compounding is a powerful ally in building your retirement wealth, it's important to be aware of factors that can erode its effectiveness. Two significant culprits are *fees* and *early withdrawals*. 

*Fees*, such as investment management fees or administrative charges, directly reduce the amount of money that is working for you and available to compound. 

Therefore, it is usually good to use investment with low fees. 

*Early withdrawals* can be even more detrimental. When you take money out of your retirement accounts before you retire, you not only stop the compounding process on that withdrawn amount, but you may also face penalties and taxes, further diminishing your overall savings. You're reducing its size and its ability to grow more in the future. Avoiding early withdrawals is essential to maximize the benefits of compounding over the long term. 

Slide 10: Putting it all together 

So, let's bring it all together. Today, we've explored the incredible power of **compound interest**. It's the fundamental principle that allows your money to grow exponentially over time, with your earnings generating further earnings. It's truly your friend in the journey of building a secure and comfortable retirement.

Click on the link below to open the online quiz.  The quiz will open in a new tab.

Note: To receive your "Badge of Completion" you will need include the your name, email and score 100% on the quiz. You can take the quiz more than once.  Your highest score will be used.

Link to online quiz  (opens in new tab)