Albert Einstein calls compound interest the “8th wonder of the world. Yet, most people are not familiar with the concept of compound interest. It is one of the most powerful wealth building tools and most people don’t take advantage of it. Conversely, compound interest can work against you. A sad reality is that a shockingly high percentage of Americans end up on the wrong end of compound interest. The longer you wait, the less powerful it is. That is because it is all about how long your money works for you.
I think part of the reason that no one takes advantage of it is because everyone is impatient and they want something that makes them rich now. Another reason is because it may not be very intuitive. I’ll give you an example of what I mean. Say you start the first day of the month with a penny. Then it doubles every single day of the month. At the end of the month (31 days), any guess on how much you’ll have?
$10,737,418.24. Mind blown.
Well my mind was blown when I was first told this as a child. Obviously, if it doubles, that is assuming a 100% return, which is a very extreme example. Then again, we did just start with one cent. But what is it that makes the number so large? It’s because you reinvested the interest. I’ll explain what I mean. You invested one cent. You made a 100% return. Now, you have just made one extra cent. Congratulations! You now have two cents. Now you have to reinvest that one cent you just made. So on day two, you’re adding your one cent gain to your original one cent invested. Now you make a 100% gain again. Wow, your portfolio is on fire! Now you have a whole four cents. You get the point. You just keep reinvesting your gain and eventually you end up with $10,737,418.24.
What happens when you don’t reinvest? Well assume you are still getting 100% returns. On the first day, you still gained one cent. However, this time instead of reinvesting it, you spent it. So now on day two, you still have just one cent. Get your 100% gain again, and you earn a penny again. If you never reinvest, you will be making 100% returns on one cent everyday. At the end of the month, you will have earned and spent 30 cents, and you will still have your original penny. I don’t know about you, but I prefer the $10.7 million.
Let’s apply this to a more realistic hypothetical situation.
You invest $1,000. Your average return for the next 30 years is 7%, which is reasonable. If you reinvest and leave it alone for those 30 years, it’ll be $7,612.26.
What does the $1,000 look like after the first 15 years? $2,759.03. As you can see, the growth over the last 15 years is much larger. Time is your friend. Give your money as much time as you can to accumulate and you will see exponential growth.
Now what if, instead of 30 years, we let the $1,000 grow for 40 years? By giving your money an extra 10 years, it grows to a whopping $14,974.46. This why you HAVE to invest as early as you can. Do NOT put it off. You aren’t going to get time back. One of the most common regrets people have is not investing earlier. Time is literally money.
Be intentional with your investing. Set concrete goals for yourself. Track your progress. Say you want to be a millionaire in 40 years. If you invest $418 per month for 40 years, you’ll be at just over a million assuming a 7% average return every year. That’s just an example. Personally, I think 40 years too far in the future. Setting a goal that long could be limiting yourself to what you’re really capable of. You can’t predict what could happen in those 40 years. The best way to approach it is set short term and long term goals. Track your progress periodically and adjust your goals accordingly.
One of the biggest hurdles for most people is actually taking action. Then they just put it off and they lose all this precious time. You may feel overwhelmed as to how to invest your money or get out of debt, but that’s why I want to help. The point is that you NEED to get started.