You are currently viewing The Magic of Compound Interest

The Magic of Compound Interest

Fans of the Harry Potter book series know about Hermione’s beaded handbag that shows up in the final book. If you aren’t a Harry Potter reader, then maybe it’s time to consider your life choices. Yes, that sounds a bit tough but really, there is a reason the books are popular and have crossed into lore.

Those familiar with Hermione’s bag knows she used a bit of magic to turn a small, ordinary handbag into something that could hold what seems like an endless number of supplies – books, jeans, a framed portrait and even a tent. Impressive.

Funded special-needs trusts are a bit like that bag. Money and other assets can go into the trust and then those funds magically turn into (OK, pay for) entertainment, healthcare, housing, clothing, food, education and just about any need for the beneficiary of the trust (the person with a disability for whom the trust was created).

For those not familiar with the purpose of a special-needs trusts, head to my website at www.robwrubel.com for other articles and my books on special-needs planning. This newsletter talks about one power of investing and how important investing trust assets can be to provide support and a high quality of life for your family member with a disability.

A bit of magic and luck are nice to have; I prefer the power of compound interest. Hermione’s bag looked like a simple handbag and its great power was the ability to carry an enormous amount of supplies in something quite small.

There was a major drawback. The bag carried only what was put into it.

Investing in a special-needs trust brings a different power – that of compound interest. What is that? It’s the additional growth that comes when your money makes money and you reinvest it to speed up its growth. Let’s say you have $100 and it earns 5% this year. At the end of the year, you have $105. Pretty easy math and not a compound rate of return. Compound interest starts when you take your original money plus the new money from interest and invest all of it. With simple interest, the basic return, $105 after two years equal $110. 5% on the principal each year. With compound interest, you have extra. At the end of the second year, you have a total of $110.25. A little extra. Admittedly, not that much over the short term. The real power of compound interest happens over time and that original contribution of $100, invested over 20 years, becomes $265.33 and after 30 years is $574.35 (check out the math at Investor.gov. https://www.investor.gov/financial-tools-calculators/calculators/compound-interest-calculator. Add some zeros to the original amount and you get an idea of how much money can be earned by keeping funds invested over time.

That little piece of math magic means that a trust (or an account used to fund a trust) can create funds for future use far above how much was put in originally. If invested well and over enough time, the trust could get to a point where the interest alone can support your family member’s supplemental needs.

Benefits pay for basics – shelter, food and medical expenses. Life is more than basics and we want our family members to live fulfilling and complete lives where they (with support) can engage with their families, social circles and communities to the extent possible. This could mean they need additional funds for transportation, improved medical devices, streaming services, communication technology and more. The trust can be used to pay for most of it.

The catch is that creating enough assets to fund a trust takes time and starting early helps compound that asset growth. Regular monthly savings makes an investment account grow even faster. Your financial planner can help estimate how much you might need in the future and what contributions and returns are needed to get there.

I wish I had a magic wand that I could use to cast spells to create money from the air or to convince people to start saving as soon as possible. While those wands don’t exist, we can all take part in a little financial enchantment by starting to invest and allowing compound interest to work its magic.

 

This article is not intended as investment advice or representative of any specific investment strategy. Consult with your legal, tax and investment team before taking any action.