The Piggy Bank Is Costing You Money
“Magic exists! It’s real, I’m telling you!”
– Houdini
{Harry Houdini was a great magician, illusionist, and escape artist who, as the President of the Society of American Magicians, wanted to uphold professional standards and expose fraudulent artists.}
I’m a huge Harry Potter fan and hate being a muggle. No hats, wands, or cloaks, and I love my school, but it’s no Hogwarts. My favorite spell was the “Geminio!” spell.[i] Remember when Harry was in a bank vault, and this spell just multiplied all the treasure? This was the “doubling” charm; whatever it was used on just kept replicating itself, multiplying automatically, endlessly.
What if I told you there was a real-life version of this “magic” you could use to multiply your money? And that instead of just sitting in your piggy bank, your money could be “working” to increase itself, and that the sooner you begin, the more you will have by the end? Compound interest is a concept that, once understood, feels just like magic. It’s a way money “compounds” or makes more money and will keep doing so if you let it.
I know most of us own piggy banks. And some of us think money is safe inside our sock drawer, the pocket of a specific jacket in the closet, a make-up box, under the bed, or inside a loose floorboard. And sure, it’s likely that no one will find it there and steal it. But you’ve already learned from the previous chapters that the value of money erodes or lessens with time. So, if you had hidden $100 in your sock drawer in the Summer of 2021, it would be worth less by the Summer of 2022. More specifically, “inflation” (which we covered in the previous chapters) was ~9% in 2021.[ii] This means you would need $109 in the Summer of 2022 to buy what you could have bought with $100 in the Summer of 2021.[iii] Get what I mean? You lost about $9 because you “hid” your $100. So it didn’t “grow,” while stuff became more expensive.
So, what should you do instead? First, you should put your money in a bank. It will be just as safe, if not safer. And it will be doing something more – it will be “working” to multiply itself because of the magic of interest.
I haven’t yet explained “interest,” so here goes.
* “Interest” is real-world magic *
Interest is the payment one is given for putting money in a bank. So, when you and I deliver our money to banks, they reward us by paying interest.
And what do they do with our money? They lend it to others.
So, on the one hand, banks pay interest to “savers.” As long as banks pay us, savers, for depositing our money, we’ll likely keep banking with them.
On the other hand, banks have “borrowers” to whom they charge interest. Borrowers pay interest to banks for the privilege of getting funds to use – to buy a house, a car, or start a business, and so on.
The bank is in the middle. It uses the money from some people and lends it to others. It pays the “savers” interest by crediting it to their bank accounts. Then lends the money to “borrowers,” usually for a higher interest rate, so the bank makes money for its work. It’s a win-win-win scenario for all three entities involved. The saver is rewarded for giving her money, the borrower gets funds he can use, and the bank keeps the money safe and makes a profit.
Now, while money in banks is almost always safe, some element of risk is involved. That’s because you’ve entrusted your money to someone else. The interest you are paid is meant to compensate you for your risk. So it’s only fair that the more the risk, the more the reward – that’s why interest rates will be higher whenever things are riskier.
That’s why in countries such as the U.S., which have stable and steady economies, the interest rate paid to savers is typically between 0.3[iv] - 4.3%[v], depending on the bank. And in countries that are lesser developed with less stable economies, the interest rates are higher. The money, sometimes called “capital” or “principal,” that savers give to banks is at greater risk. And so banks have to offer their savers a higher reward for entrusting them with their funds. That’s why many banks across India[vi] and Africa[vii] provide interest rates that are easily 7.5 - 8.5%.
If you’re wondering what happens if banks don’t manage this money correctly or if they lend too much out without keeping any buffers, don’t worry, there are rules to ensure banks can’t do this. Banks must, at any given time, maintain reserves of cash to be financially stable, stay in business, and remain trusted as a quality bank.
* The crazy little thing called “compounding” *
There are two types of interest. The concept I’ve explained above is that of “simple” interest. Deposit your principal amount in the bank, and they pay you a specific rate of that principal (aka “interest”) as your reward. For example, suppose you deposited $100, and the bank agreed to pay an interest rate of 10% each year. In that case, at the end of the year, you will have 10% of $100 (or $10) in addition to your original $100 in your account.
The second type of interest is called “compound” interest (that’s when the Harry Potter Geminio spell-like magic kicks in). It’s when the interest you’re earning also earns interest and keeps doing so, making your initial sum of money grow exponentially with time. Now it isn’t just your initial principal that’s “working” for you - all the interest you’re slowly accumulating is also adding up and also “working” for you. The longer the time for compounding to do its work, the more you’ll have. It just takes time and patience.
I want to show you how fantastic compounding can be. The only rule is you don’t withdraw the earnings paid to you on your original sum – you leave it all in there to grow.
Do you know how much you'll have if you take just one penny and double it every day for 30 days? Over $5 million.[viii] It works like this:
Day
Amount
1
$0.01
2
$0.02
3
$0.04
4
$0.08
5
$0.16
6
$0.32
7
$0.64
8
$1.28
9
$2.56
10
$5.12
11
$10.24
12
$20.48
13
$40.96
14
$81.92
15
$163.80
16
$327.68
17
$655.36
18
$1,310.72
19
$2,621.44
20
$5,242.88
21
$10,485.76
22
$20,971.52
23
$41,943.04
24
$83,886.08
25
$167,772.16
26
$335,544.32
27
$671,088.64
28
$1,342,177.28
29
$2,684,354.56
30
$5,368,709.12
That’s the magic of compounding! As your savings grow (and you aren’t touching them), you’re earning interest on a larger and larger total pool of money. The good news is that most banks pay “compound” interest.
I don’t know if you’ve figured out by now that the more often this “compounding” thing happens, the more money you will make. If interest is compounded annually, it will be calculated and paid once a year. If it is compounded quarterly, it will be calculated and paid every three months – with each of those payments and all that interest going into the pool to work for you. If interest is compounded monthly, it is calculated and paid every month. If interest is compounded daily, it is calculated and paid every day!
If you want to see the difference the frequency of compounding can make, take a look at this:
$100 in a bank at 10% interest compounding ANNUALLY
Year 10
$259
Year 20
$673
Year 30
$1,745
$100 in a bank at 10% interest compounding MONTHLY
Year 10
$271
Year 20
$733
Year 30
$1,984
And $100 in the bank at 10% interest compounding DAILY
Year 10
$272
Year 20
$739
Year 30
$2,008
Do you see? The interest rate is the same, and the period is also the same – 30 years. So choosing daily compounding over annual compounding can make you $263 more. And here, the initial amount was just $100.
Different banks have different frequencies of compounding. So research the banks you are considering and ask them how often interest is accrued.[ix] You will make more money with a bank that pays you interest more often than the one that pays you less frequently, even though they might offer the same “rate” of interest. (There are many “compound interest calculators” online that you can tinker around with[x]).
So there you go! By putting your money in a bank, you make interest, and your interest makes interest. It is all “passive” income – in the sense that you don’t have to work for it (like doing a chore); you just put it to work and leave it to “grow.”
* To save or to invest? Why not both? *
Now that you know how much you can benefit from earning interest on your funds, it’s time to start making some. Where do you find interest? The best way to start earning interest is by opening accounts at banks and investment firms.
The differences between commercial banks and investment firms can be blurry; for now, just know that banks help us “save” while paying us interest and are better for short-term money goals. In contrast, investment accounts help us “invest” and are more appropriate for mid to long-term money goals. Both offer a return/reward.
Generally, banks are considered safer than investment firms because money held in well-reputed banks is usually protected, “insured,” or “regulated.” Organizations such as the FDIC (the Federal Deposit Insurance Corporation) help ensure that such funds remain safe and easily accessible by the savers at any time. You can earn guaranteed, steady interest rates from a bank, making a savings account perfect for your short-term goals, such as saving up for a bike, birthday present, holiday, or even a car.
You can open a “Savings” or a “Checking” account at a bank. Savings accounts are specifically designed to help you save and accumulate money. While checking accounts are mainly used to pay bills or make frequent withdrawals from Automatic Teller Machines (A.T.M.). I’m sure you’ve seen A.T.M.s before – they look like vending machines and are found at airports and stores. You can access the cash in your savings account by inserting the A.T.M. card supplied by your bank and typing the PIN/code you set when opening the account). Interest rates on savings accounts are usually higher than rates paid on checking accounts. However, many checking accounts do not pay interest, so make sure to do research and ask questions before opening an account.
Here are some important questions to ask before opening an account:
o “What interest rate do you offer on savings accounts?”
o “How often is interest compounded (yearly, monthly, or daily)?”
o “Do you charge any monthly or service fee for having the account?”
o “Will I be required to maintain a minimum balance?”
o “Is it easy to transfer money online?”
o “Will I receive an A.T.M. or debit card?”
o “Is there a limit for transferring/withdrawing money?”
o “Is there a fee for transferring/withdrawing money?”
Make sure you like the bank, the people who work there, and the answers they give because you are trusting them with your money.
With an investment account, you’re planning ahead. You’re using some of your money to “multiply” it for a longer-term goal, such as going to college or planning to travel once you’re old enough. Investment accounts are used for goals some years away because it's harder to withdraw from such accounts. You’ve got to leave the money in there for longer for it to grow. In some investment accounts, you are in charge of making the investments; in others, there are people you entrust your money to that will (hopefully) continuously find ways to make that money grow. Of course, whoever manages the funds could make wrong choices – or they could make excellent ones. Yes, there’s a higher risk, but that’s why there’s also a higher return. With an investment account, you might earn interest, but you can do more – you can buy things like stocks, bonds, or mutual funds and make a lot of money if done correctly.
* Slices aren’t just for Apple pies *
Investment firms, similar to banks, have different account types – and they have many more options. For example, you can have a general investment account (such as a “brokerage” account), or you can have accounts for specific goals (such as a “retirement” account or a “529 college savings” account).[xi]
Now I don’t want to confuse you with investments yet – this chapter is about putting your money to work. We’ll get to investments later in the book. For now, I just want you to open suitable accounts. I recommend opening an investment account that allows you to buy stocks – specifically, “fractional” shares of stocks.
You are probably already familiar with “stocks.” Buying stocks helps you become a part-owner of a public company (such as Apple, Amazon, Tesla, or Netflix). And “fractional” shares of stocks allow you to buy pieces or slices of one share of stock. As I write this book, one share of Apple costs $163 – you may not have that much money or want to invest so much in just one share of one company. The solution is to buy a “fraction” of that one share. For example, perhaps you have $5 to spend on Apple to buy a fractional share. You didn’t buy a whole share for $163, but you are still an investor in Apple. Pretty cool, right?
We’ll cover stocks and other investments in more detail later; for now, open the correct type of investment account. Ask the investment firms you are considering the same questions you asked when researching banks. It’s also important to ask if you can buy “fractional” shares and whether they will charge you for each trade. I recommend Fidelity or Schwab because both allow you to purchase less than a whole share of stock, and there are no fees for making trades.”[xii]
* To-Do *
You will have a “To-Do” in every chapter because this book isn’t just about reading and learning. It’s also about doing.
To make your money work for you, open a savings and an investment account.
#1 - Break open your piggy bank, check all your pockets, dig under the floorboards and couches, and gather your treasure. Deposit your money in a savings account at the bank you chose after all your research. Ideally, your bank should be close to your house, or at least the A.T.M. should be nearby or convenient. If you aren’t yet 18, you’ll need a parent or guardian to help you open an account.
#2 - Select an investment firm based on your research, and open an investment account. You’ll need to “link” this investment account to your savings account so you can easily transfer money and begin investing. Again, if you aren’t yet 18, ask a parent or guardian to help.
* Chapter 1 Takeaway *
[i] ‘Doubling Charm,’ Harry Potter Wiki, https://harrypotter.fandom.com/wiki/Doubling_Charm
[ii] ‘Consumer prices up 9.1 percent over the year ended June 2022, largest increase in 40 years,’ The Economics Daily, U.S. Bureau of Labor Statistics, https://www.bls.gov/opub/ted/2022/consumer-prices-up-9-1-percent-over-the-year-ended-june-2022-largest-increase-in-40-years.htm
[iii] ‘CPI inflation calculator’, U.S. Bureau of Labor Statistics, https://www.bls.gov/data/inflation_calculator.htm
[iv] ‘Best Savings Accounts – January 2023,’ U.S. News, https://money.usnews.com/banking/savings-accounts#:~:text=%244-,Best%20Savings%20Account%20Interest%20Rates,%25%2C%20according%20to%20the%20FDIC
[v] ‘Best Banks for Savings Accounts,’ Investopedia, https://www.investopedia.com/personal-finance/banks-pay-highest-interest-rates-savings-accounts/#:~:text=Best%20Savings%20Accounts%3A&text=Western%20State%20Bank%20%2D%204.25%25%20APY,CFG%20Bank%20%2D%204.15%25%20APY
[vi] ‘9 banks offering from 7% to 7.50% interest rates on savings accounts in 2022,’ Mint India, https://www.livemint.com/money/personal-finance/9-banks-offering-from-7-to-7-50-interest-rates-on-savings-accounts-in-2022-11668854400032.html
[vii] ‘Top 12 Best Savings Account in South Africa 2022,’ Money Today – South Africa, https://moneytoday.co.za/best-savings-accounts/
[viii] ‘5 Fun Ways to Teach Compound Interest,’ Ramsey Solutions, https://www.ramseysolutions.com/financial-literacy/teaching-compound-interest
[ix] ‘Interest: Definition and Types of Fees For Borrowing Money,’ Investopedia, https://www.investopedia.com/terms/i/interest.asp
[x] ‘Compound Interest Calculator,’ The Calculator Site, https://www.thecalculatorsite.com/finance/calculators/compoundinterestcalculator.php
[xi] ‘Investing isn't just about money—it's about your future,’ Fidelity, https://www.fidelity.com/go/join-fidelity-investments?imm_pid=700000001008875&immid=100920&imm_eid=ep71500665265&gclid=Cj0KCQiAgribBhDkARIsAASA5bvcRKhzh4TW9nvyjUoP4L_AZNmZ8tVjjpHQfsLsGU3WVXhZROowA4waAhpaEALw_wcB&gclsrc=aw.ds
[xii] ‘Schwab Stock Slices™’ Charles Schwab, https://www.schwab.com/fractional-shares-stock-slices
