Forbes- December 13, 2021
Over time, making little changes to your finances can add up.
Some of the steps you can take to build compounding into your life include:
- Investing in a money market account to generate more interest than a savings account
- Micro-investing to put your spare change to work
- Splitting monthly investment and saving contributions into weekly or biweekly payments
- Investing in dividend-paying stocks (and reinvesting those dividends)
- The earlier you take these steps, the longer they have to work – and the greater your outcomes will be later
When it comes to payday, a hefty paycheck has a more significant impact than a dinky one. But in the rest of your finances, it’s not all about the big moves. Even baby steps can add up over time and introduce the benefits of compounding into your life. (In more ways than one!) If you’re ready to take charge of your financial future, here are 5 little things you can do that will have compounding effects.
1. Save with money market accounts.
Many people use savings accounts to set aside money for their rainy day fund, future down payment, or even fun money. Unfortunately, the sad reality is that savings accounts don’t pay out as much interest as they used to – most don’t even scratch 1%.
But many money market deposit accounts (MMDAs) do. These accounts are like a savings account in that you deposit money and earn interest. However, some MMDAs also come with checking writing and debit card privileges.
And because they can invest in vehicles like government securities, commercial paper, and certificates of deposit (CDs), they often earn more interest than a regular savings account. For instance, in December 2021, the highest savings account rate just scratched 1%. By contrast, the highest money market account earned 1.25%.
Many banks and credit unions offer money market accounts to their members. But these MMDAs may carry hefty minimum deposit requirements or high fees that make accessing them prohibitive.
If you want to watch your money grow, try a low-risk money market account and see how your returns stack against your regular ole bank account. It’s saving – with a twist.
2. Try micro-investing.
You already know that investing is one of the best ways to grow your wealth and compound your returns. But this article is about the little ways you can see compounded effects. And one of the best ways to compound your wealth is with micro-investing.
Micro-investing is the process of investing small sums over time. By contributing manageable amounts of money (typically less than $1), you can compound your growth over time without breaking the bank.
One popular micro-investing strategy is to round up your regular transactions. For example, investment apps like Acorns connect to your financial accounts and “round up” to the nearest dollar every time you use your debit card. Then, they use your skimmed funds to invest in fractional shares of stocks or ETFs.
Micro-investing helps you build wealth for two reasons:
- You’re investing at all – every penny helps! For instance, if you invested $30 per month at 5%, your account would be worth $25,000 in 30 years. Not too shabby!
- You’re taking advantage of dollar-cost averaging, or regularly investing in the same securities regardless of price. Over time, your costs “average out” as you buy the dips, highs, and everything between.
3. Invest in dividend-paying stocks.
Another little way to compound your growth is by adding dividend stocks to your portfolio. These are stocks that pay out a tiny profit – usually 2-4 times per year – just for owning shares. Though many companies pay small sums (often less than $1 per share, per year) over time, as you buy more shares, those dollars add up!
Some companies also pay dividends in the form of additional stock. These companies come with the benefit of automatically building your portfolio over time. Just don’t forget to rebalance your portfolio and keep your diversification at your desired level, lest you favor one company or industry too heavily.
4. Don’t forget to reinvest your dividend payments!
If your investments pay out more stock as dividends, over time, you’ll naturally boost your holdings. But cash payments come with an alternative: withdrawing your earnings. While it may be tempting, a better move may be to reinvest your dividends back into your portfolio.
By taking advantage of dividend reinvesting, you’ll get all the benefits of micro-investing, dollar-cost averaging, and compounding in one more. Your dividends will buy more shares, increasing your future dividend payments, which buys more shares…and the cycle continues. Nowadays, most brokers offer automatic dividend reinvestments – even those that don’t offer fractional shares. Better yet, the shares you buy with your reinvested dividends are typically fee- and commission-free.
But best of all, dividend reinvesting is a “set it and forget it” strategy. Once you turn on reinvesting, it stays on. All you have to do is monitor your diversification and rebalance your portfolio on time.
5. Divide your monthly investment into weekly contributions.
Instead of making monthly or even biweekly contributions to your investment accounts, consider making smaller payment every week. Though it seems simple, over time, this move will show compounded effects – and you don’t have to contribute an extra dime.
There are two reasons this method helps:
- You’ll invest more money in a year. For instance, if you contribute once per month, you’ll make 12 “payments” to your account in a year. But if you contribute a half-payment every two weeks, you’ll make 26 half-payments, or 13 whole payments.
- Since you’re buying the same stocks more frequently – even at lower prices – you’ll enjoy automatic dollar-cost averaging every month.
Let’s look at a couple of examples to highlight how this strategy can compound. Since it’s difficult to accurately reflect dollar-cost averaging, we’ll show the impact of investing monthly versus weekly. In both examples, we’ll assume that you invest $100 upfront and earn 5% interest over 10 years with monthly compounding.
Example 1: Investing Monthly
In our first example, say that you invest a lump sum of $400 at the beginning of each month. Over the next decade, you contribute $48,100 and earn $14,436.41 in interest for a final account balance of $62,536.41. That’s not too shabby!
Example 2: Investing Weekly
In our second example, let’s say that you invest a lump sum of $100 every Monday. Over the years, you contribute $52,100 to your account and earn $15,526.06 in interest. At the end of the decade, your final balance is $67,626.06 –$5,090 more than our first example.
(Psst: If you’re saving money in your regular savings or money market account, more frequent contributions add up there, too!)
The earlier you start, the better off you’ll be!
From investing in a money market account to splitting your contributions, any of these 5 little steps can bring you the joys of compounding. But the earlier you start, the more time your money has to grow, regardless of which strategy you choose.
And if you’re ready for a bigger leap, it might be time to try investing with the expertise of AI to back you up!
By Q.ai – Make Genius Money Moves, Contributor
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