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.”