Have you ever wished that you could have more money, without all the effort? Or are you concerned you won’t have enough saved for retirement or your child’s education?
Luckily, there’s actually a simple way to accomplish those things if you’re willing to learn how to put your money to work for you. It’s called compound interest, and it can help you exponentially grow your wealth.
What is Compound Interest?
When people think of interest, they often think of debt. But interest can work in your favor when you’re earning it on money you’ve saved and invested.
Compound interest can be defined as interest calculated on the initial principal and also on the accumulated interest of previous periods. Think of it as the cycle of earning “interest on interest” which can cause wealth to rapidly snowball. Compound interest will make a deposit or loan grow at a faster rate than simple interest, which is interest calculated only on the principal amount.
Not only are you getting interest on your initial investment, but you are getting interest on top of interest! It’s because of this that your wealth can grow exponentially through compound interest, and why the idea of compounding returns is like putting your money to work for you.
The magic ingredient that makes compound interest work best is time.
The simple fact is that WHEN you start saving outweighs HOW much you save.
An investment left untouched for a period of decades can add up to a large sum, even if you never invest another dime. But the sooner you start, the better.
Compound Interest in Action
Let’s see how compound interest works with an example. Below, Alice, Barney and Christopher experience the exact same 7% annual investment return* on their retirement funds. The only difference is when and how often they save:
Alice invests $5,000 per year beginning at age 18. At age 28, she stops. She has invested for 10 years and $50,000 total.
Barney invests the same $5,000 but begins where Alice left off. He begins investing at age 28 and continues the annual $5,000 investment until he retires at age 58. Barney has invested for 30 years and $150,000 total.
Christopher is our most diligent saver. He invests $5,000 per year beginning at age 18 and continues investing until retirement at age 58. He has invested for 40 years and a total of $200,000.
Barney has invested 3 times as much as Alice, yet Alice’s account has a higher value. She saved for just 10 years while Barney saved for 30 years. This is compound interest: the investment return that Alice earned in her 10 early years of saving is snowballing. The effect is so drastic that Barney can’t catch up, even if he saves for an additional 20 years.
The best scenario here is Christopher, who begins saving early and never stops. Note how the amount he has saved is massively higher than either Alice or Barney. Is it so astounding that Christopher’s savings have grown so large? Not necessarily – what is most remarkable is how simple his path to riches was. Slow and steady annual investments, and most importantly beginning at an early age.
Young Pros Invest Now
Compound interest favors those that start early, which is why it pays to start now. It’s never too late to start — or too early.