Paying Compound Interest

Paying Compound Interest

On today’s show, we talk about paying compound interest.  We’ll discuss:

  • The impact of time
  • The impact of the interest rate

Be sure to scroll down for the charts and graphs that help illustrate how this can impact you.

Watch: Paying Compound Interest

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Listen Now: Paying Compound Interest

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Free Download: The Impact of Paying Compound Interest

Compound interest is a tricky subject.  So we created this free download to help illustrate how it can impact your life.  To download your free copy, please click on the button.  

Paying Compound Interest Example 1: The Mortgage

How does compound interest make you pay? The best example is the mortgage. Most of us borrow money to buy a house. And one of the common decisions is choosing between a 15 or 30-year loan. So let’s look at how this plays out.

30 Year Mortgage

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You borrow $100,000. Right now, rates for a 30-year mortgage are about 4%. This means your monthly payment is about $478. Because of the effects of compounding, the total cost of this loan over three decades will be $71,870.

15 Year Mortgage

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If you borrow the same amount over 15 years, your interest rate is lower—about 3.38%. But your payment is also higher. It jumps to $709, not quite twice as much. But over 15 years, your total interest cost is $27,576.

A 15-year mortgage, if you can afford the payment, will save you over $44,000 in total interest expense. That’s nearly half of the loan amount.

For most people, a lot goes into their decision about whether to do a 15-year or a 30-year loan. And the primary factor is the size of the payment. But this illustrates how powerful time can be.

Paying Compound Interest Example 2: Credit Cards

Let’s look at another common example. Credit Cards. Many credit cards require you to pay 2% of your balance as a minimum payment. And credit cards often have rates which could exceed 20%, but let’s use 20% for this example.

Credit Card Repayment

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You start with a balance of $5,000 and make no other purchases. Your minimum payment is $100. You pay this each month until you eliminate the debt.

It will take you 9 years, and it will cost you over $5,800 in interest. This means you pay more in interest than your original purchases.

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Financial Planning

About the Author

Neal Watson is a Certified Financial Planner™ Professional and a Financial Advisor with Fleming Watson Financial Advisors  He typically works with people who are planning for retirement.  Fleming Watson is a Registered Investment Advisory firm located in Marietta Ohio.  Our firm primarily serves Marietta, Parkersburg, Williamstown, St. Marys, Belpre, Vienna and the surrounding communities in Washington and Noble Counties in Ohio and Wood and Pleasants county in West Virginia.

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A Fishy CD Ad

On today’s show, we talk about a fishy CD ad.  It reminds us if things sound too good to be true, they probably are.

Watch: A Fishy CD Ad

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Recently, the Federal Reserve reduced short term interest rates, again. And this move impacts savers in a big way. Earlier in the year, we were able to find short term CD’s—meaning 1 year or less—with an annual yield of 2.3% or higher.

Since then we’ve seen those rates drop significantly. The national average annual yield for 6 month CD’s is 0.91%. The highest annual yield reported is 1.85% to 1.9%.  If you are a saver, this low-interest-rate environment is awful. CD buyers are begging for any kind of yield right now.

A Fishy CD Ad

Recently, a client asked us about an ad he saw in a newspaper in Myrtle Beach. The advertised rate for a CD was over 3.5%. That’s almost 4 times the national average. And it is nearly double the highest reported rate by bankrate.com.

An ad like this is going to get people’s attention.

But things like this also make the alarms go off in our head. What is this company doing that allows them to offer a CD with this kind of yield? So we did a little digging, and to no surprise things look a bit suspicious.

1.  It’s Not A Bank Running The Ad

The first thing of note, this isn’t a bank advertising this. Brokerage firms have access to FDIC insured CD’s. And at times those rates are better than what local banks offer. But, when the advertised rate is this much larger?  It raised an eyebrow.

2.  An Insurance Agency Advertises This.

The second thing which got our attention: The company running the ad primarily sells insurance products. And this made us dig a little deeper.

We found this gimmick has been around for a few years. Here is how it works.

The Gimmick

The agency has an ad for a 3.5% 6 month CD. You want to invest $10,000 in one. The agency buys a CD for 1.3%. After 6 months, the bank issuing the CD pays you $65. The agency then pays you $110. You get your 3.5% yield.

A Fishy CD Ad

CAUTION! High Pressure Sales Tactics Ahead

For that $110, the insurance agency gets a captive audience with a yield-hungry, conservative saver. Then they use high-pressure sales tactics for annuities and other insurance products.

Ads like this aren’t necessarily a scam.  But the tactics push ethical boundaries. These agencies design these ads to get your attention and get you in the door. You see, they’ll only talk to you about this in person. And when they have you sitting in front of them, they can put on the full court press to try and sell you something else.

Many times, what they are selling is not always in your best interest. So, if you see an ad like this, be careful. Remember, if it sounds too good to be true, it probably is. And if you are in doubt, talk to an advisor you know and trust.

What's On Your Mind?

Do you have a question about what’s happening in the world of finance or investing?  Is there a topic that has you curious?  We’d love to hear from  you.

 We’ll do our best to answer it in a future episode.  To submit your question, fill out the form.  If you prefer, you can send us an email directly.  That email address is neal@flemingwatson.com

Enter Your Question Here

Financial Planning

About the Author

Neal Watson is a Certified Financial Planner™ Professional and a Financial Advisor with Fleming Watson Financial Advisors  He typically works with people who are planning for retirement.  Fleming Watson is a Registered Investment Advisory firm located in Marietta Ohio.  Our firm primarily serves Marietta, Parkersburg, Williamstown, St. Marys, Belpre, Vienna and the surrounding communities in Washington and Noble Counties in Ohio and Wood and Pleasants county in West Virginia.

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Bonds With Negative Yields

There are over 17 trillion dollars of bonds with negative yields. Does this mean you are paying someone for the privilege of loaning them money? And why are people buying them?

Monday Morning Money—Bonds With Negative Yields

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$17 Trillion of Bonds With Negative Yields

There has been a lot of attention lately about the more than $17 trillion of debt with negative yields. Much of that is issued by foreign governments. But there is about a trillion dollars in corporate debt with negative yields
 
So does this mean you are paying these countries for the privilege to loan them money?

The Basics of Yield

Yield is the return you will earn if you buy and hold a bond until it matures. It factors in the interest rate, the return of your principal, how long until it matures, and the price you pay.
 
So keep in mind, yields and interest rates are NOT the same thing. In some cases, these bonds could pay the investor interest. German bonds currently do not. But you can have a bond with a negative yield which does pay interest.
 
The thing which causes their yields to be negative is the price investors have to pay. Paying a high price and holding the bond to maturity assures you of a negative return—even though you might collect interest along the way.
 
Let’s look at a simple example. You have a bond which matures 10 years from now. It has a coupon or interest payment of 1.6% per year. You collect that for the life of the bond. When the bond matures, the issuer typically redeems them at a price of $100. If you buy this bond for a price of $116 or more, your yield will be negative. Why? Because the return from your interest won’t be enough to compensate for the high price you have to pay.

Why Buy Bonds With Negative Yields?

This is where it helps to understand the relationship between yield and bond prices. Yields and prices are inversely related. That means if one goes up, the other goes down. Think about a teeter totter. On one end you have prices, the other side yields.
So why would someone buy bonds with negative yields? If you know you are going to lose money holding these notes, why wouldn’t you just put the money under your mattress?
 
One theory is speculation.  Those who are buying these notes are speculating that yields will go even lower. That’s the only way buying a bond with a negative yield results in a profit.
  
Those who are buying these notes are speculating that yields will go even lower. That’s the only way buying a bond with a negative yield results in a profit.

Buy Low, Sell High

There is a saying in the investment world. Buy low, sell high. With bond yields at extremely low—and in some cases negative—levels, it means prices are already high. Buying bonds with negative yields, or longer term bonds with very low yields, seems like a recipe for the opposite.
 

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Financial Planning

Neal Watson is a Certified Financial Planner™ Professional and a Financial Advisor with Fleming Watson Financial Advisors  He typically works with people who are planning for retirement.  Fleming Watson is a Registered Investment Advisory firm located in Marietta Ohio.  Our firm primarily serves Marietta, Parkersburg, Williamstown, St. Marys, Belpre, Vienna and the surrounding communities in Washington and Noble Counties in Ohio and Wood and Pleasants county in West Virginia.

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Listen Now: Death of the Stretch IRA (6 Minutes)

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Monday Morning Money Ep. 01

3 ideas to plan for lower future returns

We face a number of financial risks in retirement.  And, when most people hear the word “risk” they automatically think about a stock market crash.  And while those events are possible, one threat always impacts our nest egg.  Every year, everything you buy costs more.  We’ll talk about that in this week’s episode of Monday Morning Money.

Yes there is a Big Mac Index. It was created by the magazine The Economist

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Plan for A Better Retirement

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Other things we buy also cost more.

Every Year Everything You Buy Costs More: The First Class Stamp

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Every Year Everything You Buy Costs More: The Big Mac

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When I Was A Kid…

What are some of the things you remember buying years ago?  What are some of the stories your parents or grand parents told you about the prices they paid for the things they purchased?

Leave your comments below.

Video Transcript

We face a number of risks in retirement. Most people focus their attention on another stock market crash like we saw in 2008. Rightfully so. That was rough. But there are other threats we need to consider and plan for. One of the most significant ones: Every year everything you buy costs more.

Who hasn’t heard a parent or grandparent tell us “when I was a kid, a loaf of bread was a nickel and a movie was a quarter. And I had to walk up hill both ways to buy both!”

We all know bread hasn’t been a nickel for decades, and when I was a kid, Buck night at the Athena and Varsity in Athens was a treat.  And my parents dropped us off.

Every year, everything you buy costs more.  It is a simple way to explain inflation. Over time, the prices of the things we buy increase.

But we don’t always notice in our day to day lives. It’s not until we look at the cumulative effect over many years, that we see just how much inflation impacts our wallet.

One of the best ways to illustrate this is a first class stamp.

A little more than a month ago, your cost to mail a letter increased to 55 cents. And while this was the largest increase ever announced by the postal service, it probably didn’t seem like a big deal.

But if we go back 30 years, you could buy 4 stamps for a dollar. Over time the cost to mail a letter has increased gradually.  A penny here, two cents there, And now thirty years later, it will cost you more than a dollar to mail two letters.

Stamps aren’t the only thing which has increased in price.

In 1988 a big mac cost two bucks. Now three decades later, this signature sandwich has more than doubled in price. There is actually something called the Big Mac Index.

The same can be said for

Bacon,
Movie tickets,
gasoline,
bread,
Ice cream
and electricity.

All of these items cost more.

Prices go up, And this impacts how we need to plan for retirement. When thinking about what you’ll spend in retirement, most people look at how they spend their money right now. And that’s a good starting point. But it won’t remain constant over time.

If something costs a dollar today, you should expect to pay more in the future.

If inflation averages 3%,

That same item will cost $1.16 in five years.

It jumps to $1.34 in 10 years.

In fifteen years, you can expect to spend over 50 percent more.

After two decades, that one dollar item jumps to a dollar eighty,

And after 25 years, the price will more than double.

For years, we were able to depend on Social Security to help us with these rising costs.  But in more recent years the cost of living adjustments have been much smaller.  And on top of that, Medicare premiums have been eating up much of those annual increases.

This means we must rely on our savings to provide the raises we will need in retirement. Without a good plan, Inflation could be as much of a threat to your nest egg as a major stock market crash.

So, what’s your plan to deal with this threat?

Leave your thoughts or questions in the comments section below. We’d love to hear from you.

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Emergency Fund Part 2

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Why is it important to have an emergency fund?

In our last video, we discussed how you can start or improve your savings habits to build an emergency fund.  Today we will talk about why it’s important.  An Emergency fund can protect  your most important assets, like your home or your car.  It can help reduce stress when you are facing difficult times.  Having a few months of expenses saved also protects your future.  And, an emergency fund will save you money.

Did You Miss Part 1?

In Part 1 we offered tips to help you start or improve your savings habits.  Click the button below to watch.

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Improve the Return on Your Emergency Fund

Would you like to improve the return on your cash type savings accounts.  These three online banks offer an easy link to your local bank account and can improve the interest you receive on those funds.   All of them are FDIC insured.

Synchrony Bank

Ally Bank

Capital One

Note:  We have expereince with both CapitalOne and Synchrony bank.  We do not receive any compensation for providing links.

What’s on your mind?

We’d love to hear from you and we would also love to provide content relevant to you and your situation.  If you have a question or a topic you would like covered in a future video, let us know.  We would love to address it in a future video.  Also we are always open to suggestions about how we can improve the content we create.  Your comments are always welcome.

Emergency Fund – Part 1: How to Get Started

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Did you hear about the Government Shutdown?  Some 800,000 government workers didn’t get paid for a little over a month.  Have you stopped to consider how you would pay your bills if you didn’t get paid for a month?  What about 3 months?  Do you have an emergency fund?  (You probably should).

The first part of this video series offers a few tips on how you can start or improve your emergency fund.

Bonus Tips

Emergency Fund Bonus Tip 1 – Consider reducing your 401(k) contributions temporarily

To bolster your short-term savings, you may want to consider reducing your contributions to your 401(k) temporarily.  This can free up cash flow to add to your emergency fund.  Once  you reach a comfortable level, resume the deferrals.  One note of caution:  Pay attention to the company match, it’s free money.  Don’t reduce your contributions to a level where  you won’t maximize the employer matching funds.

Emergency Fund Bonus Tip 2 – Use Your Tax Refund.

Do you normally get a large tax refund?  Consider using part or all of it to boost your short term cash reserves.  Whether you expect it or not, it can be an easy way to help you get to that goal.

Emergency Fund Bonus Tip 3 – Take Advantage of Direct Deposit

Is your paycheck deposited directly into your bank?  Consider splitting the deposit to two accounts, one your normal check account, and the other your cash reserve fund.  Sometimes it is easier to save it, if it never reaches your spending account.

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Online Savings Accounts

Some of the online banks make it easy for you to save and reward you for doing so.  Most of them have no minimum balances, and all three of them pay you interest.  They have an easy to use online interface.  And you can transfer money back and forth to your local checking account.  We have experience using both Capital One and Synchrony Bank (and neither of them pay us anything to talk about them.)  Three of the more popular ones are linked below.

Capital One

Synchrony Bank

Ally Bank

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What Happens Next?

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Last year was the first negative year (calendar year at least) in the US Stock market since 2008.  Are we in for a rebound or are we in for continued struggles? Most people are wondering what happens next.  We’ll look at some historical data to see if it offers any guidance about what we should expect in 2019.

 

Watch this and other videos on our YouTube Channel.

If you would like an audio only format, you can listen below.  Also visit our podcast page here.

Since 1950, the stock market has decreased 14 times.  On average, one out of every four years results in a negative result.

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What Happens Next?

As you can see from the image above, the S&P 500 has generated back-to-back negative years just 3 times since 1950.  The first happened in 1973 and 1974.  And more recently, it happened in 2001, 2002, and 2003.  If you go back to the mid 1920’s, it happened in 1929-1932 and then from 1939-1941.  In other words, negative returns in consecutive years are not common.

What happens next: 1 year later—

In the year following the last 14 calendar year declines since 1950:

The market went up 11 times.  The average gain was 17%

What happens next: 3 years later—

Three years after the last 14 declines, the market was positive 13 times, with an average annual return of 13.6%

What happens next: 5 years later—

Five years after the last 14 declines, the market was positive 13 times, with an average annual return of 11.3%

We Would Love To Hear From You

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Ask A Question

Did You Miss This Post?

A couple of weeks ago, we updated our favorite performance chart, the asset allocation quilt.  Click on the button below to see more.

Checking Our Crystal Ball

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It is the time of year when we financial advisors look into our crystal ball and try to see what is going to happen next year.  If the big Investment Banks and brokerage firms can do it, why can’t we?

Click on the video to watch.

As luck would have it, predicting the future is really hard.  Huge firms with smart people and tremendous resources don’t fair much better than consulting a horoscope or the farmers almanac.

(Click images to enlarge)

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So many things happen during the year which cannot be seen, even if you were able to use a crystal ball.  Nobody knew—in advance—2017 would be as calm and as good as it was.  Likewise, nobody foresaw the extreme down-up-down craziness experienced this year.

But it hasn’t stopped any of these large firms from taking a guess at what might happen in 2019 either.

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Would You Like Your Own Crystal Ball?

Here is the link to the one we purchased.  Fair warning, it shows finger prints really badly.  And if you are hoping you will be able to see the future?  Well I hope it works better for you than it did for us.

We Would Love To Hear From You

Do you have a question you would like to have answered on a future episode?  Enter the information in the form to the right.  We will try to address it in an upcoming video.

Ask A Question

Visit Our Retirement Learning Center

Are you thinking about retirement?  please stop by our retirement learning center for helpful information about Social Security and other general retirement planning topics.

Follow us on Social Media…

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Scoreboard Watching: December 2018

Scoreboard

The Dow Jones Industrial Average acts as a scoreboard for investors.  It provides an easy way for investors to tell whether the market has had a good or bad day.  But from time to time, investors need to recalibrate what those big moves mean.  After all, a 100 point move today doesn’t mean what it used to.

The Dow Jones Industrial Average is an unmanaged index.  An investment cannot be made directly an index.  Returns are not guaranteed. Past performance is not indicative of future results.

Recalibrating the 25  Worst Days For the Dow

If we were to state the 25 worst days for the Dow Jones Industrial Average, this is how they would look.  The 25th worst day, would equate to a drop of about 1,700 points.  The worst day ever, would be a drop of over 5,600 points.

Scoreboard

Yes you saw what you thought you saw….

There is a picture in the video of the scoreboard from the end of the Ohio State victory over their rival on November 24.  We were there to witness such a momentous occasion.  But just in case, here is the photo again.

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If you—or someone you know—is planning to retire soon, visit our retirement learning center.  It has plenty of video content to help you make informed decisions about your retirement.

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