Most Powerful Force in the Universe
We continue this month’s theme on the Basics of Investing with understanding Compound Interest.
Einstein apparently called it, the “8th wonder of the world” AND “the most powerful force in the universe!”
With Compounding Interest - $1+$1 doesn’t equal $2. Instead, it can equal $2.11. Then, the next month, $2.11+$1 doesn’t equal $3.11. Instead, it equals $3.28. The month after that? $3.28+$1 = $4.52. If we make that $100 each month, in 3 months, you would have about $452, if your money was in a high yield savings account, earning 5.5% APY! You get the idea!
Compounding Interest is the amount of money you save or contribute + the interest + TIME you continue to save and contribute.
Just ONE of those ingredients will make the money multiply like crazy. Let’s take the amount of interest. I’m going to ask you a simple question:
Would you rather receive $10,000 a day, every day for a month or one penny that doubles each day for a month?
(Yes, this is a trick question.)
The answer?
With the magic of compounding, at the end of one month, the doubling penny will have earned you $10,737,418 compared with $310,000 if you had collected $10,000 per day.
Put another way, the doubling penny earns you 35 times what the $10,000-a-day option does!
OK let’s get real here. The reason the penny example delivers such a HUGE result is that we’re using a massive interest rate. Doubling your money every day means a 100% daily interest, and real-world numbers are typically a lot smaller. But this is just to prove my point that you really only need one of the ingredients in the Compounding Interest Formula to make a huge return on your investment.
Now let’s take a look at this with TIME.
Investor 1 saves $5000 per year for 10 years, starting at the age of 25.
Investor 2 doesn’t even start saving until 35. He invests the same amount at $5000 per year for the next 30 years.
At the Age of 64, Investor 1 has almost $200,000 MORE than Investor 2 although she only saved for 10 years, while he saved for 30. Why? Because she saved EARLIER and had more time for that money to compound!
Compounding interest works like a snowball. The longer it’s rolling down that hill and with more snow, it can grow to be 3, 10, 35, 75 times the size of the initial snowball.
So, how do you take advantage of compounding interest? Well, start NOW! Even if you are past the ages of the investors in the chart, the time to start is NOW. You only have your future to thank you.
Next, make sure you are taking advantage of either a super high yield savings account or taking advantage of a stock index fund. Right now high yield savings accounts are earning 4.5-5.5% while a stock index fund, on average, has yielded 10% in the last 10 years and about 9% in the last 15.
Lastly, it does matter how much you’re contributing, but to be honest, do what you can. Anything is better than nothing. Remember, the penny vs $10K comparison? As long as you’re putting your money in something that will earn you the most money, you can turn that penny into … well yes, if interest was 100%, then it can become over 10 MILLION DOLLARS!
With Love & Gratitude,
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