Compound interest is sometimes referred to be the “eighth wonder of the world.” It has the ability to transform a little investment into a fortune over time. In this article, we will explore the power of compound interest and how you can use it to grow your wealth.
Compound interest is interest earned on both the principle amount and any prior interest earned. For example, if you save $1,000 in a savings account that pays 5% interest each year, you will have earned $50 in interest after the first year. However, instead of receiving interest on the first $1,000, you will now earn interest on $1,050, which implies that you will earn $52.50 in interest in the second year. This process continues indefinitely, with the amount of interest earned increasing year after year.
Time is the key to unlocking the potential of compound interest. The longer you allow your money to grow, the more powerful the compounding impact becomes. This is because compounding boosts not just your main investment but also the interest generated on it. Compounding has a higher impact on your overall returns the longer you let your money to compound.
Let’s look at an example to see what I mean. Assume you invest $10,000 in an index fund with a 30-year average yearly return of 8%. Your initial $10,000 investment would have increased to $100,626 after 30 years. This indicates that your investment has multiplied by ten! The sum of $90,626 is the consequence of compounding interest on the original $10,000.
Assume you wait another ten years before drawing down on your fund and leave it in the same index fund. Your investment would have increased to $217,364 after 40 years, more than doubling the amount invested after 30 years. This indicates that the additional 10 years of compounding has increased your returns by $116,738.
Most of us know the story of Warren Buffet, currently ranked 6th Richest person in the world with a net worth of $107 Billion. Some of us might even know that he has on average returned 22% per annum on his investments. But what most of us might not know is that, he started investing when he was 11 years old and that 97% of Warren’s wealth was created after he was 65 years old. This is a real-life example of the power of compounding interest and time.
A tale of caution, if you’re not careful, the power of compound interest might work against you. This is due to the fact that debt, like interest gained on assets, may compound over time. Credit card debt is an excellent example. If you hold a loan on a credit card with a 20% annual interest rate, your debt will double in just over 3.5 years. This means that the longer you keep the debt, the more difficult it will be to repay.
So, how can you use the power of compound interest to increase your wealth? The first step is to begin investing as soon as possible. The longer your money is allowed to compound, the bigger the impact on your overall returns. Even if you can only afford a modest amount of money to invest each month, starting early and allowing your money to compound will have a major influence on your long-term wealth.
Reinvesting your money is another option to take advantage of the power of compound interest. This means that instead of withdrawing your investment’s interest, you reinvest it back into your portfolio. This allows you to earn income not just on your original investment but also on the interest you earn.
In conclusion, the power of compound interest cannot be underestimated. It has the potential to transform a little investment into a fortune over time. You may use the power of compounding to develop your wealth and achieve your financial objectives by starting early, reinvesting your profits, and giving your assets time to compound.
