Last week we looked at the key financial principle of paying yourself first, by saving some of the income you earn. Like our Jamaican proverb advises, “Parson christen ‘im pickney fus,” which means that a parson takes care of his child first, so should you prioritise your own financial affairs.
When your income is stretched to the limit taking care of bills and other obligations, it may seem impossible to find an extra dollar to put aside for the future. Recognise that if all your money is spent paying other people, then you really have nothing to show for all of your hard work.
Slow savings – a waste of time?
It may require you to make a big sacrifice to save consistently, and to be disciplined not to deplete your funds unless you have a true emergency situation. However, when you look at the slow progress on your savings growth, you may be tempted to wonder if your sacrifice is pointless.
Many people give up on saving because they are frustrated with their inability to quickly attain a large lump sum in their account. It’s important to understand the factors that help to increase your savings, so that you can be assured that your efforts to pay yourself first are not in vain.
Our Jamaican adage, “Every mickle mek a muckle,” assures us that even a small amount of savings will eventually grow to something substantial. This is not just wishful thinking; there are rational explanations for savings growth. Let’s look at how your ‘mickle’ can become a ‘muckle’.
Interest gives you more
When you put your funds in a deposit account at a financial institution, you’re actually lending money to the institution. Like other money lenders, you should earn an interest for the use of your capital, so you need to ensure that the account you choose to save in offers interest payments.
Some financial institutions seem to think that they are doing you a favour by accepting your money. They charge fees for making deposits, or penalize you for not having a minimum amount in your account. So instead of earning from lending them your funds, you are actually losing money!
Your money will grow if you save in interest-bearing accounts. Today’s financial landscape is very competitive, and it is your responsibility to seek out institutions to save which respect your deposits, supply regular interest and provide options to reduce or eliminate service fees.
Compounding gives a boost
To maximise savings growth, you also need to be aware of the different ways that interest is computed. Simple interest is calculated only on your principal or the money that you put into your account, while compound interest is paid on your principal plus the interest your money earned.
Let’s say that you put J$10,000 in your account three years ago. If you earned five per cent simple interest over that time, your savings balance would be J$11,500. However, if your interest had been compounded annually, your account balance would be boosted to J$11,576.25.
Your money will grow steadily if you ensure that your account earns compound interest, preferably paid every month. Check with your financial institution for the requirements to allow your funds to earn compound interest, and maintain your savings in these types of accounts.
A higher rate gives better returns
The reality is that today’s interest rates are paltry, so don’t expect to see phenomenal returns only from your savings efforts. However, it is essential to do your homework to ensure that when you deposit your funds, you earn the best possible interest rate that is available in the market.
In the above example, if your J$10,000 savings had received six per cent interest compounded annually, your account balance after three years would be J$11,910.16, while a seven per cent rate would yield J$12,250.43. If the account compounded monthly, the returns would be even greater.
Your money will grow dramatically if you seek out accounts with higher interest rates that compound monthly. You may need to put your funds into a fixed deposit instead of a regular account or choose a savings institution which offers more attractive interest rates to its depositors.
Time gives you the edge
Some people believe that they should wait until their financial situation improves to start saving something substantial. Very often, the years go by and their situation has only worsened while their accounts remain empty. It’s vital to start saving whatever you can afford right now – don’t delay!
When you put off saving, you lose the benefit of years of accrued interest. If you added J$500 each month to your J$10,000 deposit and got five per cent interest compounded monthly, after 25 years your nest egg would be over J$332,000. Your actual savings would be only J$160,000 – the rest is interest earned.
Your money will grow exponentially by combining the factors of compound interest, higher interest rates and time. No matter how much you start with, once you apply these factors to a consistent savings plan, you will experience the magic of money multiplying in your account.
You can get more detailed advice on ways to improve your finances in my new eBook, The 3 M’s of Money: How To Manage, Multiply and Maintain Your Money.
Copyright © 2016 Cherryl Hanson Simpson. No reproduction without written consent.
Originally published in The Daily Observer, January 28, 2016.
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