The Basics of Compound Interest

Jump To:
A. Introduction
B. The Basics of Compound Interest
C. Grow Your Financial Portfolio
D. The Benefits of Financial Freedom
E. Where to Open an Account
F. Stock and Companies to Invest In

Introduction

It struck me that what a lot of musicians really need is more money in their pockets, more business sense, and entrepreneurial sense. I realized that a lot of younger people don’t know the financial basics yet. I’ll be going over the basics that should have been taught to you in schools. Every American and every artist should know about this because it’s going to help you avoid being one of those tragic jazz masters who need to start a GoFund me to pay your bills when you’re older. 

Today I’m going to talk a little bit about compound interest. Don’t run away, compound interest is not multi-level marketing. It’s the power that every business person, responsible personal finance person, and every investor has taken advantage of since the dawn of time. I think as artists and humble musicians who don’t like talking about money, we need to be taking advantage of this in order to ensure the survival of our art. So, let’s talk about average stock market return over the long term.

The Basics of Compound Interest

The average annual return since adopting the S&P 500 is roughly 8%. I’ve seen that number as high as 10% and as low as 7%. The number may vary as people take averages over shorter or longer time periods; however, the thing to understand about the stock market is if you keep your money invested, and you do not touch it for the long run, you will not lose money. If you do not panic, and keep your money invested in an index fund like the S&P 500 or a Vanguard index fund, you will not lose money over a 30 or 40 year period of time. It has never happened. Historically speaking, that is as safe as bonds or a savings account. 

A lot of people say stocks are crazy, they claim that your money could be gone tomorrow. That’s true to some extent, but if you’re invested in the S&P 500, or a similar index fund, your money’s safe. In the long run, it will make money. However, if you have mattress money, which is money that’s just sitting in your checking account, you’re going to lose 2-3% every year due to inflation, inflation being your money’s worth less every year as a result of the government overproducing cash.

For the average uninitiated person who doesn’t know anything about compound interest, 8% seems like a small number; however, I’ll show you why Albert Einstein said this is the most powerful force in the universe by using a basic compound interest calculator. If you invest $1 and you’re 20 years old and you cash it out when you’re 65, which is the average age for retirement, and we take that 8% growth number, $1 when you’re retired is worth 32 X. So you might be thinking $32 is not a lot of money, but think about the growth. In this example, we only invested $1 and didn’t invest anything for the rest of our life and it grew by 32 X. Imagine if that’s a hundred, a thousand, ten thousand, a hundred thousand dollars contributed, or even a million dollars contributed. That is a ludicrous amount of money. It’s the same force that will ensure you aren’t one of those tragic jazz heroes who have to make a GoFundMe to pay your bills when you’re older. This is the type of growth that creates millionaires. The average millionaire is made by investing a little bit of your paycheck and a little bit of your gig money every month over a long period of time. Most people will not make a million dollars from their job or from their gigs over the course of their life, but if you take advantage of 32 X growth over 45 years, it’s more than possible. In fact, it should be the standard. 

On the other hand, if you invest $1 when you’re 30 years old, 10 years less time for growth, your growth is less than half. That’s why it’s so important to start today. The longer you’re invested in the market, your growth and the amount of money you’ve contributed just skyrockets. That comes around year 40, 50, and so forth. 

This is also an important message for your spending. Say you’re thinking about buying a PS5 or a flat screen TV. Rather than purchasing unnecessary things, you should be investing your money. If you invested that $500 instead of buying a PS5, you would have $16,000 in 40 years. This may be a little idealistic, but this is the real power that should really be taught in school. 

Grow Your Financial Portfolio

Now, let’s talk about a more real world example, because odds are, you’re going to invest more than $1 towards your retirement or financial future. A very common number for that is $6,000 a year, or roughly $500 a month, because that’s the maximum amount of money you can contribute to a Roth IRA account. $500 a month is something everybody can conceptualize because it’s typically less than half the rent people pay every month. If you don’t have $500 a month, contribute whatever you can. Even if you invest $1, it’ll have the same amount of growth. Let’s say you’re 20 years old and you cash out when you’re 65 and we take the 8% number we used earlier. If we calculate your portfolio using a compound interest calculator, it will be worth $2.3 million. By contrast, if you did not invest the money, and you just kept it in your checking account, your portfolio would be worth $270,000. That is not nearly enough money to live on from the time you’re 65 to a hundred, especially if you factor in unexpected medical expenses and extra insurance costs. Compound interest is the difference between jazz hero GoFundMe and a healthy portfolio. 

Let’s say you wait until you’re married, you have kids, you’re 35, and you’re starting a plan for retirement. You invest from age 35 to age 65, where you would only get 30 years of growth. You would have less than $700,000. To younger people, that seems like a lot of money, but as far as your retirement profile’s concerned, this is the bare minimum you need to live for the rest of your years. 

The Benefits of Financial Freedom

Financial freedom would help musicians in a ton of different ways. We would be able to have more bargaining power with venues, streaming companies, and labels if we weren’t dependent on them. It would help us focus on our art. In order to ensure musical freedom and a healthy retirement plan, you need to open up a Roth IRA account or a traditional IRA account as soon as possible. The difference between the two accounts is when you are taxed. With a traditional IRA, you don’t pay taxes on the money you contribute to that account this year. However, you are taxed when you take money out of the account after you retire. By contrast, with a Roth IRA, you pay taxes on the $6,000 this year. It’s included in your income tax. Then, when you withdraw money when you’re retired, you don’t pay any taxes on it. In my opinion, a Roth IRA is going to be the smarter choice.

Where to Open an Account

Where can you open up one of these accounts? There are tons of brokerages, which are companies that provide investors with investment plans and market intelligence. The one I use is called fidelity. There is also Charles Schwab and Wells Fargo. The most important thing is that you open up an account and start investing right away. 

Stocks and Companies to Invest In

The last thing I wanted to touch on is stocks and companies to invest in. For long-term investing, you need to put your money in the S&P 500. This is an index fund of the top 500 companies in the United States. They also have a dividend fund for people who want to make more money as they go. Vanguard index funds are popular as well and they have their own Vanguard 500 index within the S&P 500. All of these funds are pretty much the same; however, the important thing is that you understand compound interest, the urgency with which you need to utilize it, and the type of account you need to open in order to make sure you have a successful financial future. 

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