Ch2. Personal Finance — Savings, Investing & The Power of Compound Interest

The Magic of Compound Interest

Compound interest formula: FV = PV × (1 + r)ⁿ

Rule of 72: Years to double your money ≈ 72 ÷ annual return rate

Annual Return	Time to Double
3%	24 years
5%	14.4 years
7%	10.3 years
10%	7.2 years

Real example:

• Invest $500/month starting at 25 at 7$1.2M by 65**
• Start at 35 → only ~$600,000 by 65
• Starting 10 years earlier roughly doubles your outcome — time > amount

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Savings Vehicles Comparison

High-Yield Savings Accounts (HYSA)

• FDIC-insured up to $250,000
• Current rates: 4.5–5.5% APY at online banks
• Use for: Emergency fund, short-term goals (1–3 years)

Money Market Funds

• Invests in short-term government securities
• Slightly higher yield than HYSA
• Use for: Emergency fund parking, investment waiting room

Index Funds / ETFs

• Broad market exposure with minimal fees (0.01–0.20% expense ratio)
• Top recommendations: VOO (S&P 500), VTI (Total US Market), VEA (international)
• Use for: Long-term wealth building (10+ year horizon)

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Retirement Accounts: The Tax-Advantaged Priority

401(k) — Employer Plan

• 2025 contribution limit: **$23,500** (+$7,500 catch-up if 50+)
• Always contribute at least enough to get full employer match — it’s free money (100% instant return)
• Pre-tax contributions reduce your taxable income now; taxes paid on withdrawal

Roth IRA

• 2025 contribution limit: **$7,000** ($8,000 if 50+)
• Contributions are after-tax — withdrawals in retirement are completely tax-free
• Income limits: Phase-out begins at $150,000 (single) /$236,000 (married)
• Best for: Those who expect to be in a higher tax bracket in retirement

Traditional IRA

• Same contribution limits as Roth
• Pre-tax if eligible; tax-deferred growth
• Best for: High earners who expect lower taxes in retirement

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The Fundamental Investing Principles

1. Diversification

“Don’t put all your eggs in one basket”

• Asset class diversification: stocks + bonds + real estate
• Geographic diversification: US + international + emerging markets
• Time diversification: Dollar-cost averaging (DCA) — invest a fixed amount regularly

2. Long-Term Perspective

• The S&P 500 has never had a negative 20-year return in history
• The biggest investing mistake is selling during a market decline

3. Minimize Fees

• A 1% vs. 0.1% expense ratio difference results in ~25% less money after 30 years
• Use index funds/ETFs rather than actively managed funds when possible

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Chapter 3 Preview

Next: Stock Market & ETF Investing — brokerage account setup, index fund selection, and building your first portfolio.