How money grows

If you know how long you have until you need your savings to pay for your goals, you can figure out where to put it. It’s not a one-size-fits-all situation.

For example, you don’t want to take any risks with money for short-term goals. That probably means keeping it in an insured account. But if you play it too safe with money you’re setting aside for long-term goals and don’t take advantage of the time you have by taking some investment risk, you may end up with less than you need.

Do you care about compounding?

Compounding is what happens when you make money on the money you make. What does that mean?

Suppose you start by putting $1,000 into an insured account that earns 5% a year, compounded monthly. How much would you have after a year?

You might think you’d earn $50, which is 5% of $1,000. But in this case, you’d be wrong. Every month the account earns a little interest, which is added to the amount you deposited. Then, the next month, you earn on the new combined total, and that continues every month. Your money grows faster this way, and the longer you let it compound, the greater the effect.

In the case of the $1,000, the effect seems pretty small in the first year: $51.16 in interest instead of $50. But after ten years, you’ll have earned $647 in interest instead of $500. After twenty years, you would have made $1,713 instead of just $1,000. Better yet, if you added $100 in additional savings to your account every month, your total after 10 years would be $17,240.