PAX Explains: What is Compound Interest?

“Compound interest is the eighth wonder of the world. He who understands it, earns it … he who doesn’t … pays it.” – Albert Einstein

As the co-founder and CEO of PAX Financial, I have never heard someone bragging about compounding returns on an investment during lunch at a country club. Most of those conversations are about stock picks and trading strategies. Unfortunately, egos only tell the stories of the rare winners and omit the price that was paid to get one positive return.

Here’s how the idea of compounding works.

If you invest $1,000 and it returns 5 percent, you now have $1,050. The next year, you earn interest on not just your original deposit but the entire $1,050. This happens year after year. Your interest earns interest on top of interest. It keeps going and doesn’t quit.

A creative way to figure out compound interest is called the rule of 72. Your money will double in 10 years if you get an annual rate of return of 7.2 percent. Alternatively, if you earn 10 percent each year, your money will double in 7.2 years.

Remember this rule as you try to build up 25 times your income for retirement.

Here’s another way to understand compound interest.

On Jan. 1, would you rather receive a gift of $1 million or a penny that doubles every day for the rest of the month? Your answer should be the penny-doubler, because this scenario equates to $9.7 million by the end of the month! That’s the power of compounding, and a story to share at the country club.

Ready to have a real conversation about your retirement? Contact PAX Financial Group to see how we can help.

Checkup Time

When your money begins to get compounding momentum, it will grow. When you are winning with money, we recommend you have periodic financial checkups with a financial advisor.

Annual checkups increase the probability of financial success.

When doing a financial checkup, there are 5 things that we think should be evaluated.

  1. Net Worth. Has your net worth grown since the last time you took a snapshot? Net worth is defined by assets minus liabilities. In the past year, you should have grown your assets by saving and making good investments and/or reduced your liabilities by paying down debt. There should be a trend in a positive direction.
  2. Insurance Coverage. Do you have the adequate amount of life insurance, health insurance, disability and identity theft coverage? The amounts and types can change based on your income and obligations. Also, the insurance companies periodically change product types and actuarial tables, so you may be able to acquire new coverage types or reduce costs.
  3. Spending. It isn’t uncommon that as your income goes up, so do your expenses. Take a pulse and see if your expenses are getting out of control. Look at the last year of spending and place these costs into major categories such as food, housing, medical, dining and entertainment (just to name a few). A professional can identify if there is overspending and opportunities to apply a degree of restraint going forward.
  4. Professional Relationships. Do you have the right accountants, attorneys, insurance agents and other professionals to guide you? Maybe your complexity has outgrown their competency. Or maybe the professional business model you are using has evolved to where a team can no longer meet your needs. It may be uncomfortable, but make sure to examine your situation on a regular basis.
  5. Investment Performance. Frankly, reviewing investments more than annually is an exercise in futility that only leads to anxiety. Be sure to check, however, at least annually, that you are performing well relative to your personal goals and expectations, the risk you are taking and the overall market. Never make a knee-jerk decision to change things. If you’re disappointed, make a note and pay attention to see if the disappointments become a trend.

I know life is busy, but if you fail to get professional financial checkups every year, you may miss something that will affect you later down the road. When partnering with the right financial advisor, the conversation can be insightful and worth the effort.

Why Is This All Important?

Having effectively pulled out of broke into financial success, I find myself answering hundreds of money questions every week. I talk money with politicians on Capitol Hill as well as with senior pastors of churches, CEOs, local news stations, international organizations and (very proudly) moms and dads looking for a fair shake.

I received a thoughtful question from one of these dads: “On a scale of 1 to 10 how important is money to you?”

“Well,” I answered, “let’s look at history. Whether you think the Bible is a history book or if you think it’s the word of God, the truth is that the book contains 2,350 references to money. Money is referenced more than the words faith and prayer combined. So, if we know anything about human history, money has and will always be important. Is it important to me? Yes, and it’s important to you as well. Sometimes we just don’t admit it.”

The reason money is so important is that if it is mismanaged, misplaced or misunderstood, it can assist in divorce, broken relationships and poverty.

My interest in money is because of the way it impacts families in the community. I want to help others make a few adjustments to their current money approach. Are you ready?

Contact PAX Financial Group to see how we can help.

This material is provided by PAX Financial Group, LLC. The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. The information herein has been derived from sources believed to be accurate. Please note: Investing involves risk, and past performance is no guarantee of future results. Investments will fluctuate and when redeemed may be worth more or less than when originally invested. This information should not be construed as investment, tax or legal advice and may not be relied on for the purpose of avoiding any Federal tax penalty. This is neither a solicitation nor recommendation to purchase or sell any investment or insurance product or service, and should not be relied upon as such. All market indices discussed are unmanaged and are not illustrative of any particular investment. Indices do not incur management fees, costs and expenses, and cannot be invested into directly. All economic and performance data is historical and not indicative of future results.

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