Have you heard about the magic of compound interest? 

money magic gif man turn single bill into many

Let’s say you read my guide to the Financial Independence Retire Early movement, and your Financial Independence Number is $1,000,000. 

If you’re putting all of your money straight into a checking account, you would have to save $33,333 every year until you retire.

Do you happen to have a spare $2,777 sitting around every month? 

nope gif shaking head no

Neither do I…

But what about saving your money in your savings account? 

If it makes .01% interest, like most standard bank savings accounts, you could save $2,737 each month to retire in 30 years with $1,000,000. 

That’s a whole $40 less every month!

Still too much? 

yup gif nodding yes

Same here!

Instead of trying to save up all of your pennies, let’s talk about magic of compound interest AND how you can use it to reach your Financial Independence number! 

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What Is Compound Interest- and How Does It Work?

Basically, compound interest is interest that you earn on interest you’ve already received. 

So it looks like this!

demonstration retirement challenge knocking down one domino at year one builds to larger dominos in following years

If you put $100 into an account that makes 8% interest annually, you will make $8 in interest in year 1- and your total balance will be $108. 

If you make 8% interest again in year 2, you will make $8.64 in interest, and your balance will be $116.64.

As you can see, you make more in your second year because you gain interest on the entire balance, including the interest you gained in year 1. 

While it looks pretty small when your investment is $100, imagine you’re able to invest $1,000 each month for 5 years with an annual return of 8%.

While you would be investing a total of $60,000 over 5 years, your total balance would reach $73,414, thanks to compound interest!

By letting your money hang out in good investments, you would make $13,000 in interest over 5 years. 

Sounds pretty good, right?

How Can I Use Compound Interest to Reach Financial Independence?

Remember how you would have to save $2,777 monthly in a checking account for 30 years to reach $1,000,000? 

What would you think if I told you that you would only have to invest $706 monthly to reach $1,000,000 in the same period? 

That’s the magic of compound interest! 

If you don’t believe me, check out Bankrate’s Compound Interest Calculator.

Not bad for only investing $254,160 over 30 years!

that's it gif Katy Perry shock

How Do I Find Investments With an 8% Return?

If you’ve ever watched the S&P 500 (the index that contains the top 500 companies in the stock market), you can watch it go up and down every day. 

But if you look at the history of the S&P 500 since 1957, you will see that the average return has been about 8%

This does NOT mean that you will see an 8% return if you invest in one particular stock. 

Or that you will see an 8% return if you are constantly changing your investments. 

This means that if you invest consistently in the S&P 500 or a similar index fund, you should expect to see an average return of 8% over a 10 year period. 

Some investors watch the market and constantly make changes to their portfolios based on the ups and downs of the market.

I am not a super active investor, so I use Dollar Cost Averaging, or investing in regular intervals instead of waiting for a certain price.

Does it work? As of today’s posting date, my index fund investments are up 19.34% this year! 

james corden at laptop hmm not bad meme

Wrapping It Up

As you can see, compound interest helps you reach your goals a lot faster than just saving the money in a checking or savings account. 

Wondering if it’s time for you to start investing? 

Make sure you have your emergency fund and your debt under control.

Debating if it’s best to pay down your debt at a higher rate or invest? 

Check out the answer to that common question here: Should I Invest or Pay Down Debt? 

Are you taking advantage of compound interest? Do you want to learn more about index funds? Or dollar cost averaging? Would you like to see a Level Up guide on the Basics of Investing? Comment below and let me know! 

Do you want to reset your money mindset?

Sign up here to receive the FREE 7-Day Money Mindset Reset course!