How compounding accelerates your savings

Compounding is a powerful force that works on the extra money you earn just for keeping your money in an account, called dividends. It means that you earn dividends not only on your starting amount (principal), but also on the dividends that accumulate over time. Especially over long periods, the benefit to your savings can be substantial. 

An example of compounding in action 

Suppose you saved $1,000 each year toward your retirement, placing the money in a safe. After 30 years, you would have $30,000. 

Now suppose you placed that same $1,000 each year in an account that earns 5% dividends annually. After 30 years, you would have more than $66,000. Through the power of compounding, your earnings (more than $36,000) would be greater than the money you put in ($30,000).  

When dividends earn dividends of their own, your savings grow faster and faster. 

The ingredients that make compounding work 

Three factors determine how quickly compounding will grow your money: 

• Principal is your starting amount. For example, this could be the amount you place in a share certificate. 
• Dividend rate is the percentage your money earns, calculated on a regular schedule. 
• Compounding frequency is how often dividends are calculated. At UNFCU, dividends on savings, share certificate, and checking accounts are calculated daily. 

Increasing any of the above will grow your money faster: 

• Starting with more principal means that dividends will be calculated on a larger amount. 
• Choosing a higher dividend rate means that you will earn a higher percentage each time dividends are calculated. 
• Choosing an account with a greater compounding frequency means that the amount to which the dividend rate is applied increases more frequently. 

Why time is compounding’s secret ingredient 

The longer your money stays in place, the more opportunities compounding has to work on it. You can maximize how compounding and time work together by:  

• Starting to save as soon as you can: The adage holds true — “The best time to start saving was yesterday; the second-best time is today.” The earlier you start saving, the more time you give your dividends to compound. According to research from the US Department of Labor, if you start saving toward retirement ten years earlier, you will only need to save a third as much each month.  
• Avoiding unnecessary withdrawals: Compounding works because the amount to which the dividend rate is applied grows over time. A withdrawal means that the dividend rate will be applied to a smaller amount of money.