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If we were to give a young member of the Millennial Generation $100 to either open a high-yield savings account or set up a Robinhood trading account, which one do you think she will go with? Since this young woman is bound to have been born sometime around the beginning of the 21st century, the chances are that she would take the $50 and install the Robinhood app on her smartphone in order to start trading popular stocks such as GameStop and Netflix.
Let’s say the young woman in the example above asks a personal financial planner about her choices; which do you think the planner would choose? Without a doubt, this finance professional would first check if the savings account pays compound interest. Should this be the case, the next step would be to tell her client about the power of compounding, particularly for someone who is still in her 20s.
Assessing the Risks & the Math of Compounding Savings Accounts
If the planner sets up a scenario of depositing the $50 into savings accounts compounding 1% on a daily basis, and with a $50 monthly contribution, her client would be able to see that this strategy would yield $13,345 by the time she enters her 40s. This may not seem like a lot of money, but the planner would have to explain that increasing the monthly contribution each time she earns more income would boost her compounding power exponentially.
A positive outcome could yield hundreds of dollars, but the opposite would result in a loss of $50
Now let’s imagine that our young Millennial investor is still enamored with the idea of funding a Robinhood account with her $50, which would not be sufficient to purchase one share of GameStop or Netflix. At this point, the planner may explain to her client that $50 would be enough to enter an options contract speculating on the future price of those shares, but only if she trades on margin. A positive outcome could yield hundreds of dollars, but the opposite would result in a loss of $50.
What can we glean from this scenario? Aside from the obvious benefit of listening to financial advice, there is also the matter of perception. The Robinhood app may seem very modern and attractive, but the classic appeal of compound interest investing from an early age is undeniable.
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