The Power of Compound Interest
Compound interest is a concept that anyone who wants to understand investing and accumulating wealth must grasp. It is so important that Albert Einstein reportedly referred to compound interest as the eighth wonder of the world and the most powerful force in the universe.
What Makes Compound Interest so Important?
In simplest terms, compound interest means you will make more money the longer your investment is able to work for you. When you invest in an appreciating asset, your money earns interest. As you accumulate interest you continue to make money on your initial investment, plus earn interest on top of the earned interest, which compounds year after year.
How could that measly 10% interest make any real money? This table shows how much a $1,000 investment would be worth at age 65 if it were invested at age 45 versus 25.
Interest Rate Age 45 Age 25 4% $2,222 $4,801 5% $2,712 $7,040 6% $3,310 $10,286 7% $4,038 $14,974 8% $4,926 $21,725 9% $6,009 $31,409 10% $7,328 $45,259
Here’s another example from Kiplinger’s, Behold the Miracle of Compound Interest:
Consider this: Amy, a 22 year-old college graduate, saves $300 per month [and invests this] into an account earning 10% per year for six years. (That’s the average annual return of the stock market over time). Then at age 28, she starts a family and decides to stay home with the children full-time. By then, Amy had kicked in $21,600 of her own money. But even if she doesn’t contribute another cent ever, her money would grow to a million bucks by the time she turned 65.
How Can I Take Advantage of Compound Interest?
The formula for calculating compound interest is: A = P(1 + r)n
Where: P = principle
r = interest rate
n = time, or the number years
With this in mind, you will want to start investing now with whatever you can contribute in order to take advantage of “n“. Time is your best friend when it comes to investing and compound interest, and a little money will go a long way.
The longer time you have, the more aggressive you may want to be in order to receive the greatest rate of return. Just look at the difference in return between 8 - 10%.
Millionaire Money Habit: Wealth creators know that you can’t mess with compound interest. If a 20-year-old invests just $100 a month and gains 10% annually, they will be a millionaire by the time they become 65-years-old. Be sure to read 9 Ways to Make an Extra $100 a Month to for some easy ways to boost your income part-time. -RT
I was reading a booklet called The Wealth Guide from my bank and, surprisingly, Albert Einstein was mentioned because of the compounding interest power.
Cool post.
This is exactly the same thing why Warren Buffet hates to spend money!
When we think about a 100 dollars we usually give value to it by thinking what we could have or do with that money. While it’s the most common way to think about money, it is also something that holds back a lot of people from becoming rich.
When Warren Buffet thinks about 100$ he doesn’t think what will he get when spending it today but he thinks what will he get from it in the future - while gaining 20% interest on the money annually.
If it seems intresting then I made a post about it in my own money blog - http://mmmoney.org/?p=15
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