Compound Interest for Poor People

by Gary Foreman

Compound Interest for Poor People photo

You don’t need a lot of money to take advantage of the power of compound interest. Read on to find out how us ‘poor folks’ can apply compound interest to make a difference in our lives.

So you want to learn how to earn compound interest daily with a minimal investment. That’s a good question. And one that a reader sent in responding to another article I had written on compound interest. In the article I used an example where $1,000 was invested for 10 years at 10% interest. The reader sent in the following question.

Dear Dollar Stretcher,
Please don’t tell me that if I had $1,000 and invested it for 10 years at 10% interest I’d have a big pile of money. I don’t have $1,000 and paying next month’s bills is my biggest problem.
Still Poor

We’ve all seen articles on the wonders of compound interest. But most of us don’t have large sums of money just lying around waiting to be invested wisely. So we’re going to see how us ‘poor folks’ can apply compound interest to make a difference in our lives.

How to Earn Compound Interest

First, we do need to make sure everyone understands how to earn compound interest. Stated simply, it’s when you earn more interest today on the interest that you earned yesterday.

Let’s use the prior example. Suppose you banked $1,000 last year at an interest rate of 10% per year. Today your $1,000 would have earned an extra $100 in interest. If you leave that hundred dollars in the account it’ll earn compound interest. Next year you’d earn $110. It’s as simple as that. Interest earning interest.

Unlike some financial deals, you don’t need to be a wizard to use compound interest. There are a few simple rules that apply in all cases. If you apply them you’ll improve your financial lot.

What Makes Compound Interest So Powerful?

Earning an extra few dollars a year may not seem like much. But it can be powerful if those dollars compound year after year. Take our $1,000 example. It only earned $100 in the first year. But if you left it alone for 40 years it would earn over $4,100 in interest in the last year. Four times your initial $1,000! Think that’s not practical? It is if you set money aside when you’re 25 and keep it there until you retire at age 65.

It’s especially important when you talk about saving for college or retirement. The sooner you start saving, the harder compound interest works for you. Yes, it may be challenging to save when your income is small and you’re just starting out as an adult. But the payoff can be tremendous.

Other Compound Interest Facts

It’s always better to compound more frequently. Daily compounding is better than monthly or quarterly. You’ll begin earning interest on interest on the second day, not the second month. So you want to always choose the shortest compounding period offered to you.

Be aware of how the interest rate is being presented to you. A lower rate of interest could earn you more than a higher rate if it’s compounded more frequently.

More time magnifies the effects of compounding. Let’s say you put some money away today at 5% interest. That money will double in about 14 years. If you left the interest in the account you’d have twice as much money earning interest in years 15 through 28. It’s like you were getting 10% interest on your original savings. By year 29 you’ll be earning 20% interest on your original savings! The rest of the account will earn less depending upon how long it’s been in the account.

Time and compound interest, however, are a double edged sword. That 14% interest you’re paying on your credit card debt is actually much higher if you figure in compound interest.

Using Compound Interest to Your Advantage

OK, now let’s get down to how us poor folks can take advantage of compound interest. Could you find a way to save $5 per month? Maybe skip lunch at McDonalds or 2 fewer lattes at Starbucks. If you drive a lot you might save 2 gallons of gas by making sure your tires are properly inflated. You could skip those lottery tickets. If you look (and you really want to) you’ll probably find some way to save that $5 each month.

“But, at that rate it’ll take forever to save anything.” Well, let’s see. If we save $5 per month, earn 5% interest compounded monthly and continue to do that for 10 years what’ll we save? Well, we’ll have saved $600 (120 x 5). But the account will be worth $776. That’s enough for a purchase or repair bill.

Earning Compound Interest on Your Credit Cards

“You don’t understand. I have credit card debts. I can’t save money.” Oh, but you’re wrong, my plastic using friend! Let’s suppose you take that $5 per month and add it to your credit card payment. You’ll actually do better than the saver. Let’s assume that your credit card interest rate is 14% annually. After ten years you’ll have paid off an additional $1,315 in credit card balance.

Maybe you could do a little better. How about saving $5 per week? That’s about $21.50 each month. You might be able to save that much by adjusting your thermostat by one degree. Take a brown bag lunch to work one day a week. One less dinner out each month. Drop a premium cable channel or two. Maybe a combination of smaller savings.

Another option would be to take a part-time job or start a side gig to make a few extra dollars each month. 

Compound Interest and Saving Small Amounts

What could a little savings do for you? Well, if you just put $5 a week away at 5% interest you’d have saved $2,600 over 10 years. But your account would be worth $3,371. That’s a fair amount of money. A nice down payment for a car. Or you could remodel a bathroom. Or maybe you just want to spend the interest that will be earned on the $3,371 each year. You could spend about $168 every year forever and never touch your principal. Wouldn’t it be nice to know you’ll always have money for Christmas presents? Or to have a good start on your vacation each year?

In reality, $5 a week really isn’t very much. You really should be aiming higher. But I include that example just to show that even the smallest amounts can add up over time.

What Types of Savings Earn Compound Interest?

Where can you earn 5% on your money? We don’t make specific investment recommendations, but the stock market has averaged just about 10% over any given 10 year period in it’s history. So you’ll be able to find mutual funds that will be able to get that type of return for you.

Some mutual funds have a minimum initial purchase of $500 or $1,000. Until you reach that level, you can use a savings account or online bank.

But, maybe you’re deeper in debt and just can’t see your way out. You owe thousands of dollars on your credit cards. Short of Aunt Mary leaving you an inheritance, those cards will never be paid off. Well, you could apply your $5 per week to those cards. At 14% interest you’d wipe out $5,633 in credit card debt in 10 years! (Get 150+ tips for paying off debt faster.)

So now you have a choice to make. You can say that all that fancy compound interest stuff is just for the wealthy. Or you can recognize that the same principles work for smaller amounts. And begin to act on that knowledge. Would you give up two Big Burger meals each month to have $1,000 in ten years? Now that you know the facts, it’s up to you.

Reviewed May 2020

About the Author

Gary Foreman is a former financial planner and purchasing manager who founded The Dollar Stretcher.com website and newsletters in 1996. He's the author of How to Conquer Debt No Matter How Much You Have and he's been featured in MSN Money, Yahoo Finance, Fox Business, The Nightly Business Report, US News Money, Credit.com and CreditCards.com. Gary shares his philosophy of money here. Gary is available for audio, video or print interviews. For more info see his media page.

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