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college savings plans

The Power of Compounding: What Does It Mean?

April 28, 2009

in Money Management

We’ve all heard how investing can provide passive income and help us reach our long-term goals. But for those who do not have much money to invest, it may not seem worthwhile. When you consider the effects of compounding, however, it’s easy to see just how much sense investing makes.

Compounding occurs when an investment gives returns on both the original amount invested and the interest or returns previously gained. That means you can increase your money even if you do not add anything beyond the initial investment. Compounding takes time, but once you’ve left that money untouched for several years, you can experience impressive gains.

To illustrate how compounding works, consider an investment that provides a 5% annual return. If you were to invest $1,000, you would get a return of $50 after a year. With that additional $50 drawing interest as well, you would have $1,102.50 a year later. These gains may not seem like much, but after 25 years, that initial $1,000 investment will have earned you $2,481.29, for a total of $3,481.29. Basically, you’ve earned an average of about $1,000 per year for doing nothing.

Compounding is powerful when you only invest once. But just imagine the gains you could experience if you made regular contributions. This is how retirement and college savings plans work. Investors make a small contribution each week, month or year. All of the money that was previously in the account earns interest, as do the new contributions and the interest previously earned.

The key to taking full advantage of compounding is to start saving as early as possible. For college funds, that means starting when your children are young (or even before they are born). For retirement funds, it’s wise to start contributing as soon as you enter the workforce.

Most employers that provide benefits offer a 401K plan, which allows employees to make contributions through payroll deductions. The employer often matches the contribution up to a certain amount, and all of the money in the account gains interest. Over a period of 40 years, you should have plenty of money to retire on.

You can save up money for education and retirement even if you start late. But you’ll have to invest much more money to end up with the amount you would have had if you had started earlier. The key factor in compounding is time, so the sooner you start saving, the better off you’ll be.

It’s easy to get discouraged when you put your hard-earned money into an investment and do not see big returns right away. But if you give time for compounding to work its magic, you’ll find that your money grows more each year.

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Freshman Fund: How to Give Your Child a Good Financial Start at College

April 18, 2009

in Money Management

Coming up with the money to pay for college is no easy task. Saving up over the years starting when your child is young makes things easier. But when you have retirement savings and everyday expenses to think about, it may be difficult to find room in the budget to save as much as you’d like to.

Having help from friends and family can reduce the burden of saving for college. In the past, it was difficult for others to make contributions specifically for college expenses. They usually had to send cash or a check and hope that it would go toward college. But with the Freshman Fund, making such a contribution has become much simpler.

The Freshman Fund is a company that facilitates contributions into 529 college savings plans. Parents can create an account for a child and notify friends and family members. When they want to make a contribution, they can easily do so online. Funds are then put into a designated 529 account. If the parents have not yet opened such an account, funds are held in an interest-free account until they do so.

Those who wish to send a gift of college savings can do so even if the recipient doesn’t have a Freshman Fund account. Gift certificates may be sent to anyone with an email address. The recipient can redeem the certificate into any 529 plan. This is a wonderful way to encourage those you care about to start saving for college, and it ensures that the money will not be spent on something else.

College Money for Birthdays and Holidays

More and more parents are opting to discourage traditional gift giving for holidays and birthdays. It seems that most of the gifts end up collecting dust, wasting space and eventually cluttering up landfills. Encouraging friends and family to give money for college is much more practical, especially considering that their gifts will draw interest until your child pursues higher education.

Freshman Fund users can send email notifications to others to let them know how they can make a contribution. They could also add links to the account to birthday party invitations. These are great ways to encourage contributions as an alternative to the usual kinds of gifts.

A 529 plan can help you save the money your kids will need for a college education. And now, it’s easier than it has ever been for people outside the immediate family to pitch in. When combined with family contributions, Freshman Fund contributions can really add up. By the time your child is old enough to go to college, he could feasibly have enough money to pay for tuition, fees and other allowable expenses with little or no outside help.

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