What did Albert Einstein, well known for being smarter than the average cat, claim to be the most powerful force in the universe? … Compound interest!
Compound Interest has also been called the eighth wonder of the world and the greatest mathematical discovery of all time.
Fortunately for the rest of us, you don’t have to be a genius to understand compound interest. In fact, it’s pretty simple.
The concept is this: When you invest money you earn interest on your capital. The next month, you earn interest on both your original capital and the new interest. The third month you earn interest on your capital and the first two month’s interest. You get the picture. The concept of earning interest on your interest is the miracle of compounding.
It’s very much like a snowball effect. As your capital rolls down the hill it becomes bigger and bigger. Even if you start with a small snowball, given enough time, you can end up with an extremely large snowball. Over the period of many years, the returns you get from compounding will eventually outpace your initial contributions.
As an example, if you invest $2,000 a year at the age of 14, at a 10 percent annual rate of return, and you set aside the same amount at the same return for the next four years. In other words, you put aside a total of $10,000 over five years, beginning when you’re 14 and stopping when you’re 18. If you don’t invest another penny and your money keeps growing at the same rate of interest, you’ll have almost $1.2 million by the time you’re 65.
Most of us aren’t 14 anymore, but the point is, with compound interest, the sooner you start, the better.
Compound Interest can be a fantastic thing when you’re saving or investing money. Unfortunately, it works in reverse when you’re borrowing money and it explains why debts often spiral out of control.
If your credit card has a high interest rate and you can’t afford to pay off much each month, then it’s the credit card company that is getting the benefit of compound returns.
Understanding the power of compound interest can be a huge motivator in helping you get out of debt and start building wealth.
There are dozens of compound interest calculators, including this one, available on the internet. Try one out, see what compound interest can do for you, and start saving today.
“Those who understand compound interest are destined to collect it. Those who don’t are doomed to pay it.”
…but that $1.2M isn’t the same as $1.2M it is now (or was at age 14) – remember the Time Value of Money (TMV)
– Steven Burda –
e-mail: steven.burda.mba @gmail.com
http://www.linkedin.com/in/burda
(to connect to my professional network)
p.s. great ending quote!
The second most powerful force in the universe is aggregation. Aggregation is an accelerant to compound interest.
No successful land developer uses the first force without leveraging the second. No politician, general, priest or banker can be successful in his lifetime without effectively leveraging aggregation.
The problem these days is getting that initial $2000 together and saving the same amount each year. Starting at 14 while you are living at home is a good idea though. After that you start paying rent if you don’t own a house, and guess what, the rent keeps going up to pay the landlord’s interest charges. Few people do end up saving as it goes against the culture which says “fake it till you make it”, in other words, spend money as if you are already rich and the people you impress will help you get rich. How about this as an idea: stop spending excess money for a year or two, and start investing in a process that pays a higher interest rate than the miserable bank interest we get these days. Forget 10% per annum, how about 10% per month. Think I’m kidding, have a look into the returns that can be achieved with a good automated trading system. You might be surprised,
DA DAY CASH MONEY IS REPLACED WITH NEW TECH…..ALL DAT GOSTH MONEY AIN`T GONNA EXIST, NO MORE MONEY CRIMES……..TRACKABLE MONEY …..IM HEADDIN ECOMOMY, EFICIENCY,ND PRODUCTIVITY….BT TO KEEP IT BALANCED GRAB A POINT OF FOUNDATION. NO MORE HUMANS…….DA EVOLVED FORM IZ NOT HUMAN NO MORE,ITZ PART NOTHING….SO KEEP DAT IN MIND. WE R EVOLUTIVE LFE TRANSLATORS
I think leverage comes second before aggregation
just a personal opinion :)
I can’t figure out how they came up with the $1.2million can someone please use the compound interest formula and work it out for me. Thank you very much.
Dear Steven Burda, while your comments on the TVM are useful and worth remembering when considering compound interest over long periods of time, the fact that you use “MBA” as a formal title after your name certifies you as a complete [moderated], rendering your comments invalid at this time. No one cares, everyone has an MBA these days, myself included. Keep it to yourself [moderated].
Luzydfher is an idiot.