Chapter 2: The Snowball Effect - Growing Your Savings

Now that you’ve seen just how quickly regular savings can add up, it’s time to discuss the benefits of putting those savings to work. You can invest your savings to earn more money over time. For example, you can deposit your money in a high-interest savings account. Financial institutions pay you cash—called interest—for keeping your money with them. This interest helps grow your savings, allowing you to reach your goals sooner.

Compound Growth

If you leave your money in the account, you’ll continue to be paid more interest. You’re paid interest both for the money you originally saved and the interest you keep in the account. This process of earning interest on your interest is an example of compound growth. Compound growth—in this case, compound interest—is the most powerful tool available to help you reach your financial goals.

Every month you leave your money in the high-interest savings account, you earn more and more interest. Eventually, the money you set aside combined with the interest leads to a much larger account balance than you’d expect.

Think of a snowball. What starts as a small ball begins to collect additional snow as it’s rolled through the field. The snowball grows, and as you continue pushing, it collects snow at a faster and faster rate. The longer you continue, the faster it picks up snow and the larger it becomes. This is the same process your money goes through with compound interest. Your initial savings collect larger and larger amounts of interest, allowing your money to work for you.

Exhibit 1 – A snowball rolling over snow grows at a faster and faster rate.

The growth rate you earn and the length of time you leave your savings invested are critical. The higher the growth rate, the faster compounding works to your advantage. In addition, the longer you invest, the more times your earnings will compound.

Growth Rate

To see the impact of compound growth on your savings, we’ll consider three individual cases with different growth rates.

In the first case, we’ll consider a $5,000 savings account with 0.5% yearly interest. With such a low interest rate, it will take a while to see substantial growth. In fact, it would take 139 years for the original $5,000 to grow to $10,000. This illustrates why having money sitting around earning low interest rates isn’t helping you to build up your savings.

The second case is a savings account with 1.5% yearly interest. At this rate, it’s possible to grow the $5,000 into $10,000 in roughly forty-seven years. This means the initial $5,000 in savings has effectively gone to work for forty-seven years and earned an additional $5,000. To think of it another way, you’re being paid to do something that is already benefiting you—saving for your future.

Finally, if we consider an annual growth rate of 7%, that initial $5,000 would reach $10,000 in just over ten years.

Exhibit 2 – It could either take 139 years or ten years to double your money, depending on if you’re earning 0.5% or 7% a year.

A 7% growth rate will continue to allow the $10,000 to grow into $20,000 ten years later and $40,000 in an additional ten years.

Exhibit 3 – Similarly to the rolling snowball in Exhibit 1, compound growth has a powerful impact on the size of your savings over time.

Finally, we’ll compare how two growth rates that appear similar at first glance—7% and 8%—will grow over thirty-five years. With an initial $10,000 growing at 7% a year, you’d have $106,800 after thirty-five years. While this is exceptional growth that would help you reach your goal, let’s consider the second rate. If you achieved 8% yearly growth, your $10,000 would grow to $147,900 over the same thirty-five-year timeframe. Even though the difference in rates is only 1%, you stand to earn over 40% more.

Length of Time

The sooner you start saving for the future, the longer your money can grow. The benefit of increased time can be seen with an example. Let’s watch two new grads, Daniel and Craig, as they begin their professional lives. Daniel realizes the importance of setting aside savings, and for the first ten years after college, he saves $5,000 a year. From age twenty-three through thirty-two, Daniel sets aside a total of $50,000. If he allows that money to grow at 7% a year, at age sixty, Daniel would have a total of $459,300. Because Daniel started so early, the deposits he made grew to nearly ten times what he put aside.

Craig has heard stories of building personal wealth but has other priorities after graduation. It’s because of this that he postpones saving until the age of forty. To reach $459,300 in savings by the time Craig is sixty, he’d need to deposit $11,200 a year for twenty years. This would result in Craig setting aside $224,000 compared to Daniel’s $50,000. By delaying his savings by eighteen years, Craig didn’t allow his money the same opportunity to grow that Daniel’s had. By starting to save—even small amounts—as soon as you can, you’ll allow your savings the most time possible to benefit from compound growth.

Exhibit 4 – After setting $5,000 aside for the first ten years after graduation, Daniel was able to sit back and watch his savings grow. Meanwhile, due to the shortened timeline Craig gave his money, he had to set aside $11,200 a year for twenty years to catch up.

Exhibit 5 – Presented in a different way, Craig had to contribute over four times what Daniel did to arrive at the same account balance at the age of sixty.

Examples from Chapter 1

In the previous chapter, we considered three examples of saving for the future. Kelly was starting early to save for retirement, a couple planned to buy a house in three years and Darryl was eager to catch up on his retirement goal. These examples showed that with regular deposits to a savings account, you can amass a great deal of money. Let’s revisit those examples and consider compounded returns on the savings.

In our first example, Kelly set aside $4,000 a year for thirty-five years. As a result, we determined she’d save $140,000. If she were able to earn a 7% yearly growth rate, the balance would reach a value of $553,000—nearly four times the savings without growth.

In our second example, the couple set aside $9,500 a year for three years for a down payment, resulting in $28,500. Even with only a short period for the money to grow, the couple would have $30,500 if they earned a 7% annual return.

Finally, Darryl set aside $7,500 a year for a period of twenty years and saved $150,000 toward retirement. If he earned 7% annually, he would have $307,500—more than double the amount that was set aside.

Exhibit 6 – Kelly and Darryl earned more from growth than either set aside themselves. In fact, Kelly only set aside 25% of what she ended up with.

What you’re witnessing is money hard at work making the most of compound growth. By placing savings in an account with interest—or any return—the money you’ve saved earns you additional income as the years go by. The growth accumulates and shortens the time needed to reach your financial goals.

Final Thoughts

Compound growth is a tremendous tool available to those who choose to use it. It’s been used before by children in the field building a snowman, and now it’s time you put it to use to build your savings. By starting early and earning returns, you can put your money to work saving for your goals.

Key Takeaways

• Invest your savings to earn interest or other returns and put your money to work.

• Compound growth is critical to reaching your long-term financial goals.

• Earning a higher growth rate and starting early are key to growing your savings.

This blog is a duplicate of the recently self-published book The Snowman’s Guide to Personal Finance available for purchase here.