The Power of Money Compounding

I talked to a young couple last week who told me that they wanted to pay down the balance on their mortgage by $100k and then refinance their loan to obtain a lower payment. First, most likely their current loan servicer will allow them to make a principal reduction payment and then re-amortize their loan with a lower monthly payment as they desire for a fee of $250 or less typically. So, I talked myself out of a loan.

Second, I asked this couple why this was important to them and how old they are. They told me that they could save $70,000 in interest by reducing their loan balance by $100k today and saving interest is really important to them. I also discovered that they are 34 years old.

I told them they were correct that they would save $70k in interest; but, I asked them this question, "How much money will you lose by saving this $70k?" Of course, they were befuddled by my question. I asked them, "Do you want your money to work lazily for you or hard for you?" They replied, "hard for us." "Good, let's look at how we can make your money work hard for you."

What if you saved or invested this $100k instead? Even if you only earned 2% a year on your money your $100k would grow to $181k in 30 years assuming your money grew tax-free. Thus, you would come out $10,000 ahead. People always ask, "How can this be, I am paying interest at nearly 4% and I am only earning 2%? It's the POWER OF MONEY COMPOUNDING on an increasing balance versus paying interest on a decreasing balance.

How would their money grow if invested more aggressively? The dollar amounts shown below do not include the impact of taxes on your earnings for simplicity--

• 4% annual rate of return-would grow to $324k
• 6% annual rate of return-would grow to $574k
• 8%--annual rate of return-would grow to $1.006 million
• 10% annual rate of return-would grow to $1.744 million

Tamara and I have invested money with Vanguard into Muni Bond funds that are tax exempt that have earned over the last 10 years a range of 3.85% a year to 5.35% a year on average. And muni bond funds rarely every default, so your money is incredibly safe and it grows tax free of federal income taxes.