Why You Should Care About Compound Interest

Updated: Jun 12, 2024

Another byproduct of expedited technological advancements within the last few years is the idea that we must always be instantly gratified. This leads to more of an impatient mentality that could sometimes be very unrealistic, depending on the situation. There are a lot of things that are “worth the wait”:

Finding “the one”
9 months for a baby
Your dream career

Shouldn’t passive income be one of those things that is worth the wait? Telling someone to wait for anything is like asking them for an organ donation. You’re inconveniencing them and asking them to make a sacrifice with their time.

Exponential money growth and/or making interest on interest is not really taught in schools. It’s also not that exciting to talk about, to be honest. What will be exciting is giving your high yield savings account some love on a regular basis and feeling the security and benefits of making money simply by saving, investing and being patient. Even just dedicating one simple $20 a month item you don’t really need immediately can help you gain passive income while you sit and do nothing. The overall goal should be the comfort of knowing that one day:

You may not have to work for someone else.

You may not have to have the current career to which you have dedicated your life, so far.
You may not have to work in the same exact industry.
You may be able to retire early.

Of course, we never really know how we’re going to feel over a few years, but we do have the experience of our older family members or friends who can attest to this. After a certain number of years, one can become both disillusioned and burned out by the typical 9 to 5 and may want something new. Oftentimes, people won’t quit a job they hate due to the fact that they would not be as comfortable financially. Here is a look at what your savings can become if you don't add any new money after you open the account with the minimum of $100.

Scenario 1: You invest $100 at a 5% interest rate. After one year, you will have earned $5 in interest. Your balance will be $105.

Scenario 2: You invest $100 at a 5% interest rate, but you reinvest your interest each year. After one year, you will have earned $5 in interest. Your balance will be $105. However, in the second year, you will earn interest on both your original investment and your interest from the previous year. So, in the second year, you will earn $5.25 in interest. Your balance will be $110.25.

	Scenario 1 (Year 1)	Scenario 2 (Year 2)
Saved + Invested	$100	$105
Annual Percentage Yield	5%	5%
End of Year Total	$105	$110.25
Amount Earned	$5	$10.25

When you don’t add anything to the initial $100, the amount you make back on interest seems not worth it. The “magic” happens the more you are able to save & invest.

Think about your needs vs wants. What you spend on “wants” can be saved & invested. Everything adds up. Now, add the “wants” where you spend money that is possibly not as necessary while you’re concentrating on becoming more financially stable and/or savvy:

Multiple subscription services - One can easily have about 6 different subscriptions nowadays at about $16 per month (more or less)
Convenient food delivery services that really add up. I didn’t even add the general cost of dining out or take out vs cooking at home.
Unnecessarily expensive clothing and/or an excessive amount of clothing (which could lead to dry cleaning and tailoring expenses)
Alcohol is an example of a “want” from another BigSisFinance article that discusses the average person spending about $5,244 a year on alcohol, which includes the “extras” like ride-share services and munchies that typically come along with enjoying alcohol.
Overly expensive car (which typically leads to needing to spend on premium gas as well as premium car part repairs)

When you look at it this way, let's say you managed to chop these 5 expenses in half. This would mean you could have saved about $8,000 gaining interest while you carry on with your life.

Scenario 1: You invest $10,000 at a 5% interest rate. After one year, you will have earned $500 in interest. Your balance will be $10,500.

Scenario 2: You invest $10,000 at a 5% interest rate, but you reinvest your interest each year. After one year, you will have earned $500 in interest. Your balance will be $10,500. However, in the second year, you will earn interest on both your original investment and your interest from the previous year. So, in the second year, you will earn $525 in interest. Your balance will be $11,025.

	Scenario 1 (Year 1)	Scenario 2 (Year 2)
Saved + Invested	$10,000	$10,500
Annual Percentage Yield	5%	5%
End of Year Total	$10,500	$11,025
Amount Earned	$500	$525

Here’s a look over a ten-year period. If you started "Year 1" with $100K in a high interest savings account, the compound interest in ten years will pay you about $646 in monthly passive income or more.