How to reduce spending to increase savings and compounding interest benefit

"How to reduce spending to increase savings and compounding interest benefit" submitted by SchoolGrantsfor Editorial Team and last updated on Monday 9th January 2012

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Since your savings can grow substantially over time, now is the perfect time to get started. The earlier you save, the more money you’ll have in the future. While not having money in college seems to be a rite of passage, breaking the cycle is easier than it appears. Think of all the benefits behind saving money and reducing spending while in college. Gaining that dreaded freshman 10, 15 or 20 will be a lot harder if you are regulating your food shopping. There are many simple and fun ways to reduce spending that are available to you while in college.

There are many choices when it comes to saving money. First, identify whether your goals are long term or short term. Short-term goals are goals you want to reach in five years or less, or money you’ll need to access in an emergency.

A down payment for a house or car would be considered a short-term goal—as would saving for a vacation. Long-term goals, like funding your retirement or a child’s college education, are goals you plan to reach in 10 or more years. If you have long-term goals, then investing might make more sense.

The reason for the five-year timeline is that investing may be riskier than saving. If you’re saving to put a down payment on a house, you may not want your money in the stock market because you could lose 10 percent or more in value just before you need it. When saving with a bank or credit union, your money is insured and protected against losing value.

The first principle is very basic, but is often overlooked. This formula is the key! It is no secret, yet so misunderstood. Income - Spending = Savings. In order to increase savings, you need to either increase income or decrease spending. It is so easy to identify, yet so hard to actually do? What are some things that you are saving for? Learn the basic savings principle of paying yourself first. Also covered in this information on how to reduce your spending and increase your savings, as well as the benefits of compounding interest.

Short-Term Goals

Saving vs. Investing

Generally, we save up for short-term goals and invest for long-term goals. Short-term goals are goals you want to reach in five years or less or money you’ll need to access in an emergency. A down payment for a house or car would be considered a short-term goal – as would saving for a vacation. If you have long-term goals like funding your retirement or a child’s college education, then investing might make more sense. The reason for the less-than-five-years or greater-than-five-years timeline is because investing takes on more risk. If you’re saving to put a down payment on a house you may not want it in the stock market because you could lose 10 percent or more in value just before you need your money. When saving with a bank or credit union your money is insured and protected against losing value. Here we are going to review your savings options.

Pay Yourself First

For most people, creating a budget also means establishing a savings plan and savings goal. As a student or recent grad, the most important part of saving isn’t the amount but simply beginning the act of putting a little away each month, even if it is just $20. Putting your money to work for you as soon as possible will pay greater dividends in the long run. We’ll discuss how in a few slides. If you can afford it, put at least 10 percent of your income in savings each month. When it comes to investing, consider participating in your employer’s retirement plan.

How many of you have a savings account? The importance of saving: How to do it and why it’s important to form the habit early.

Reduce Spending

Reducing your expenses on an already-tight budget may seem difficult, but even a small change can make a big impact without taking out the fun. Simply skipping a $4 coffee or bringing your lunch five days a week will save you nearly $1,000 a year. Even sticking to a shopping list will help you avoid impulse items that can increase your grocery bill. When buying clothes, stick to the basics and make minor repairs instead of replacing them. Shop for health and beauty aids at discount stores and clip coupons to save even more. Share your favorite inexpensive restaurants, shopping tips and bargain buys.

To reduce transportation costs, consider an economy or used car. Public transportation and carpooling are other options which can also save you money at the pump as well as at the auto repair shop and in auto insurance. When eating out, shopping or going to the movies, ask for student discounts. Also check your local newspaper for free events such as art gallery openings or receptions, craft fairs, farmer’s markets and concerts in the park. Share a list of local venues that offer student discounts or free entertainment.

Savings Options

If you have money to save, there are four main options at banks and credit unions: checking accounts, money market accounts, savings and CDs (Certificates of Deposit).

Savings – Getting Started

A checking account is a way that you can start accumulating money. It pays the lowest interest rate of all the options but allows the most flexibility for transactions. If you have $100 or more then you might want to look at a savings account. Savings accounts pay higher interest rates. Compares checking and savings accounts in terms of interest earnings.

Savings – Larger Amounts

This is differences between money market accounts and CDs. Once you have a larger amount of money to save, other options become available that pay you more interest. Money market accounts have higher interest rates than checking and savings, but money market accounts limit the number of times you can withdraw your money. If you don’t need your money for six months or longer then a CD is a good option. A CD pays you more interest the longer you agree to lock away your money. Most CDs require a minimum deposit (usually from $250 to $1,000), pay a high interest rate and they don’t allow any additions or withdrawals from the CD for the period of the CD (six months to five years). If you take your money out of a CD early you could be charged a penalty, usually equal to three months’ worth of interest.

Rule of 72

Formula for calculating how quickly invested money will grow. Calculation takes into account compound interest. Formula: Take the number 72 and divide it by the interest rate earned on the account. It is an easy way to get an idea of how fast your money can grow. First, you take the number 72 and divide it by the interest rate you are earning. This tells you how many years it will take for your money to double. If you are getting 6% interest that means that 72/6 is 12 years to double your money. The numerical answer translates to the number of years it will take for the money in the account to double. For example, $5,000 in an account earning 8% interest. 72 divided by 8 equals 9. Therefore, it will take nine years for the $5,000 to double into $10,000.

Rule of 72: 72/interest rate Vs. Years needed for money to double

This graph illustrates how fast money will grow in savings or investment. Imagine you have $1,000 and put it in a savings account or invested it. How long will it take to double? The rule of 72 tells how many years it will take to double your investment. Take 72 and divide it by the interest rate you’re earning. If you’re earning 8 percent then 72/8 is 9 years—your money will double in 9 years.

Rule of 72 states that you can find out how many years it will take for your investment to double by dividing 72 by the percentage rate of growth. So it will take 9 years for your investments to double if they grow at 8% a year (72/8=9). But it will only take 6 years if your investments grow at 12% and so on. The Rule of 72 only provides an approximate answer but it is sufficiently accurate for many calculations.

Example: Write down their age, add nine years to it, then add another nine years and another nine years. Next to your age write $1,000. Now double that to $2,000 on the next line. Double the $2,000 to $4,000 and the $4,000 to $8,000 on the last line. This is how fast your money grows (assuming 8 percent growth each year):
Starting at age 25: $1,000
Age 34: $2,000
Age 43: $4,000
Age 52: $8,000
Age 61: $16,000
In 36 years, you’ll have 16 times the money you started with!

Power of Compound Interest

Compound interest has been called the eighth wonder of the world. And with good reason. It magically turns a little bit of money, invested wisely, into a whole lot of cash. Even Albert Einstein -- a bit of a smarty pants -- is said to have called it one of the greatest mathematical concepts of our time.

The principles of simple and compound interest are the same whether you're calculating your earnings from a savings account or the fees you've accumulated on a credit card. Paying a little attention to these principles could mean big payoffs over time.

When you save or invest, your money earns interest or appreciates. The next year, you earn interest on your original money and the interest from the first year. In the third year, you earn interest on your original money and the interest from the first two years. In the third year you earn interest on your capital and the first two years' interest. You get the picture. The concept of earning interest on your interest is the miracle of compounding. And so on. It's like a snowball -- roll it down a snowy hill and it'll build on itself to get bigger and bigger.

This one takes a lump sum of money and compounds it monthly over a fixed period of time at a fixed annual yield. Plus it allows you to add monthly contributions. There’s an easy rule you can use to work out how your savings or investments can grow with compound interest. Just divide the interest rate (or average annual return) into 72. The result tells you how long it will take for your money to double without further savings.

To be completely accurate, you would need to deduct something from the interest rate if you wanted to allow for inflation. For example, if you allowed for 2% inflation, the real interest rate would be 4%. Use the rule of 72 to remind yourself of the power of compound interest.

Put in its simplest terms, the phrase compound interest means that you begin to earn interest income on your interest income, resulting in your money growing at an ever-accelerating rate. It is the reason for the success of every person on the Forbes 400 list and anyone can take advantage of the benefits through a disciplined investing program. Benjamin Franklin was famous explaining to people that it was the best way he knew how to get rich.

This difference shows the value of starting a savings plan early. Suppose student A says she’s going to save $100 a month for 10 years. Student B says he’s going to wait until he’s making more money and then he’ll save $100 a month for 20 years. Who will have saved more money? Student A contributes $12,000 but ends up with nearly $73,537. Student B contributes $24,000 and ends up with only $46,435.

Savings Growth

Shows that saving money every month can quickly grow to a substantial sum. Saving money isn’t exciting unless you can do something with it—like achieving your financial goals. We’ve seen how fast our money can grow, but what will the money do for us? what you would do with the money they saved. What could you do with this money?

How To Succeed

Accumulating money is possible by starting off with a few good habits now. You’ve spent the past few years of your life preparing to earn a good income. Now’s the time to be sure you protect your future earnings by building a budget and planning to achieve your goals. This can be done by tracking expenses, finding ways to save that fit your lifestyle and then using your savings to pay down your student loan debt and start a savings program.

Savings Calculator Worksheet

Now is the best time to save for the future. Saving today can lead to significant rewards down the road. The opportunity to enjoy a house, car, travel and a secure retirement is within reach. Use this savings calculator to see how savings put aside today can grow substantially over time. For example, if you save $100 a month after graduation at 8 percent interest for 30 years, you’ll have $149,036.

5 Years 4% 5% 6% 7% 8% 9% 10%
$25 a month $1,657 $1,700 $1,744 $1,790 $1,837 $1,886 $1,936
$50 a month $3,315 $3,400 $3,489 $3,580 $3,674 $3,771 $3,872
$75 a month $4,972 $5,101 $5,233 $5,370 $5,511 $5,657 $5,808
$100 a month $6,630 $6,801 $6,977 $7,159 $7,348 $7,542 $7,744
$250 a month $16,575 $17,002 $17,443 $17,898 $18,369 $18,856 $19,359
$500 a month $33,150 $34,003 $34,885 $35,797 $36,738 $37,712 $38,719
10 Years 4% 5% 6% 7% 8% 9% 10%
$25 a month $3,681 $3,882 $4,097 $4,327 $4,574 $4,838 $5,121
$50 a month $7,363 $7,764 $8,194 $8,654 $9,147 $9,676 $10,242
$75 a month $11,044 $11,646 $12,291 $12,981 $13,721 $14,514 $15,363
$100 a month $14,725 $15,528 $16,388 $17,309 $18,295 $19,351 $20,485
$250 a month $36,813 $38,821 $40,970 $43,271 $45,737 $48,379 $51,211
$500 a month $73,625 $77,641 $81,940 $86,542 $91,473 $96,757 $102,423
20 Years 4% 5% 6% 7% 8% 9% 10%
$25 a month $9,169 $10,276 $11,551 $13,023 $14,726 $16,697 $18,984
$50 a month $18,339 $20,552 $23,102 $26,046 $29,451 $33,394 $37,968
$75 a month $27,508 $30,828 $34,653 $39,069 $44,177 $50,092 $56,953
$100 a month $36,677 $41,103 $46,204 $52,093 $58,902 $66,789 $75,937
$250 a month $91,694 $102,758 $115,510 $130,232 $147,255 $166,972 $187,842
$500 a month $183,387 $205,517 $231,020 $260,463 $294,510 $333,943 $379,684
30 Years 4% 5% 6% 7% 8% 9% 10%
$25 a month $17,351 $20,806 $25,113 $30,499 $37,259 $45,769 $56,512
$50 a month $34,703 $41,613 $50,226 $60,999 $74,518 $91,537 $113,024
$75 a month $52,054 $62,419 $75,339 $91,498 $111,777 $137,306 $169,537
$100 a month $69,405 $83,226 $100,452 $121,997 $149,036 $183,074 $226,049
$250 a month $173,512 $208,065 $251,129 $304,993 $372,590 $457,686 $565,122
$500 a month $347,025 $416,129 $502,258 $609,986 $745,180 $915,372 $1,130,244
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