August 16th,  2024  [5 min. read]

By Drew W. Boyer, CFP®

After heading out this past weekend on a Sunday morning bike ride down, I had the idea of how to achieve similar risk v. reward activities. 

My usual low-risk bike path down and back to the Horseshoe with the high reward of fresh air and exercise, took an unexpected turn when I got stung on the forehead halfway through. Did I stop? Nope. I kept going because the ice pack and baking soda were at home and it needed to wait.  Perseverance in any situation pays. 

Know what else pays? Compound interest. It’s one of those ‘magical’ financial principles that can seem a bit boring at first glance, but trust me, once you understand it, it can completely transform your approach to saving and investing. Whether you’re planning for your kids’ college, saving for a dream home or vacation, or building an emergency fund, the power of compound interest can help you achieve your goals with less risk and more reward. Let’s break it down and see how it works.

Saving for College: Low Risk, High Reward

Let's start with saving for college. Every month, my wife and I set aside a portion of our income into a college fund for our girls. It's not a huge amount, but it's consistent. The idea here is low risk: we’re not gambling on the stock market or trying to pick the next big winner. Instead, we’re relying on the power of compound interest.

Here's the beauty of it: as our savings grow, so does the interest we earn. It's like a snowball rolling down a hill, picking up more snow as it goes. By the time our girls are ready for college, they’ll have a significant amount saved up. The high reward? They can go to college to better themselves without having to worry about the cost, and my wife and I won't be burdened with taking out loans. As the saying goes, "Those that know how it works, MAKE it. Those that don't, pay it."

Saving for a House or Vacation: A Little Each Month

Now, let's talk about saving for a house or a dream vacation. The principle is the same. Every month, set aside a bit of money into a dedicated savings account. It doesn’t have to be a large sum, just something you can consistently contribute.

Over time, these small deposits add up. The interest earned on your savings grows as well, thanks to the magic of compound interest. Before you know it, you’ve got a nice chunk of change that can be used for a down payment on a house or an unforgettable vacation. It's all about being patient and consistent.

The Emergency Fund: No Risk, High Reward

Finally, let’s discuss the importance of an emergency fund. Life is unpredictable, and having a financial safety net can make all the difference. We keep our emergency fund in an FDIC-insured account. This means it's completely safe, with no risk of losing our principal.

The high reward here is peace of mind. Knowing we have a 'paid-up insurance policy' for when life throws us a curveball is invaluable. Whether it’s a sudden medical expense, car repair, or any other unexpected cost, we’re prepared. And that security is worth its weight in gold.

The Power of Compound Interest

Compound interest is the secret sauce that makes all these savings goals achievable. It's a simple concept: you earn interest on the money you save, and then you earn interest on the interest. This cycle continues, and over time, the growth can be astounding.

Let’s break it down with a simple example. Imagine you start saving $100 a month in an account that earns a modest 5% interest per year. After one year, you’d have $1,200 in contributions, plus about $30 in interest. In the second year, you’re not just earning interest on your $1,200 in contributions; you’re also earning interest on that $30. This compounding effect accelerates your savings growth over time.

Staying Committed

The key to reaping the benefits of compound interest is consistency. Make saving a habit, and stick to it. Set up automatic transfers from your checking account to your savings accounts to ensure you’re always putting something aside each month. It doesn’t have to be a large amount—what matters is that you’re consistent.

It might seem slow at first, but over time, you’ll see your savings grow exponentially. And remember, the earlier you start, the more time your money has to grow. So, don’t wait—start saving now, and let the power of compound interest work for you.

Wrapping It Up

So, there you have it: my take on low-risk, high-reward financial planning. It’s all about leveraging the power of compound interest, saving consistently, and being prepared for the unexpected. Whether you’re saving for college, a house, a vacation, or just building up an emergency fund, the key is to start now and stay committed.

Remember, financial success isn’t about making big, risky bets. It’s about making smart, consistent choices over time. And trust me, the rewards are worth it.