Can Seniors Still Benefit From Compound Interest?
Even if you’re later on in life, or already in retirement, you could still benefit from compound interest.
Updated on Apr 20 2020
When heading towards retirement, it’s important to diversify your methods of saving. This means taking advantage of investments and any workplace retirement plan while also factoring in any relevant Social Security benefits and pension. When it comes to investing for your retirement, you have a lot of options. And, you should always remember the importance of compound interest. Even if you’re later on in life, or already in retirement, you could still benefit from compound interest.
What is compound interest?
First, what is compound interest? Compound interest is interest that can be used to continue to grow even more interest. Simple interest occurs when you deposit savings into a bank account. That account has an interest rate, and you earn that percentage of your deposit after one year. So, if you’ve deposited $1,000 into an account with a 3% interest rate, you’ll have $1,030 after a year. However, if this account uses only simple interest, you’ll only gain an additional $30 the following years. But, compound interest is not built on the principal amount of your deposit, but the full amount of your account with interest included. So, after another year with compound interest, your account will have grown to $1,060.90. You’ve gained an additional $.90 in interest, and this amount will grow year after year.
How to take advantage of compound interest?
So, how do you take advantage of compound interest? The easy answer is to save early and often, which is good advice for any form of retirement savings. Because compound interest builds off of itself in a sort of “snowball effect,” the longer you keep an account open, the more your interest will grow.
You may think that compound interest can only really benefit you from a younger age, but that isn’t necessarily the case. Like most financial decisions, it comes down to your personal situation. If you’re still getting ready for retirement, an account with compound interest could be a good choice for you. This would be an account that you would feel comfortable not withdrawing from until well into retirement. This account could be an integral aspect of your retirement plan and help you accelerate your savings.
If you’ve already retired, you may not be able to take full advantage of compound interest. But, you may still receive some benefit. If you’re early on in your retirement and have the ability to make a large deposit in a new account, you could reap the benefits of compound interest in several years. It’s also important to consider how many years you can reasonably expect to live out in retirement. This way, you’ll be able to make a reasonable decision as to how much compounded interest you will be able to benefit from.
How to choose a compound interest account
There are several factors to consider when choosing a savings account with compound interest. One of the most important to consider is how often interest actually compounds. This frequency will determine how quickly you accumulate interest, and how much you’ll earn before needing to withdraw. Some accounts can compound interest daily, while others operate on a monthly or yearly schedule. Obviously, you’ll want to choose an account with the highest frequency of compounding interest.
Additionally, the interest rate will be one of the largest deciding factors. The higher the interest rate, the faster your account will grow. And, it’s worth mentioning that an account with a lower interest rate that uses compound interest will likely grow your savings faster than an account with a higher interest rate that only uses simple interest. This depends on the specific rate, of course, so be sure to compare closely when making a decision.
While you have no control over this factor, the amount of time you’re able to leave your savings in this particular account will affect your decision. If an account’s interest rate and compounding frequency won’t allow your savings to grow at a rate that aids in your retirement planning or spending, it’s probably best to look for other options.
Can compound interest be a negative?
When making investments or savings decisions, compound interest will almost always benefit you. However, it can be a major detriment when it comes to loans and debts. As we’ve seen, compound interest can cause your savings to grow at a much faster rate than simple interest. And, the same can be said for your debts. Credit cards that carry a compound interest rate, for example, can quickly send you into greater debt if you only make the minimum payments. This is because the interest could end up compounding into a “snowball effect” more quickly than your payments are reducing it. So, be sure to avoid taking any loans or signing up for any credit cards with compounding interest rates. This way, you’ll save yourself from some potentially snowballing debt.
Compound interest is your friend when it comes to retirement planning. Like all retirement saving strategies, saving early and often will help you make the most of compound interest. But, this doesn’t mean that you can’t take advantage of compound interest if you’re closer to retirement or already retired. Be sure that you consider all aspects of a particular account carefully, and speak with a financial advisor if you want to be sure about your decision.
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