Albert Einstein came up with a lot of good stuff in his day, but one of his best quotes is “Compound interest is the eighth wonder of the world”. To be sure Einstein didn’t invent compound interest, but like all that other stuff about relatively and black holes, he knew it was really important.
Don’t worry though, you don’t need to be an Einstein to understand or benefit from compound interest, all you really need is time.
Compound interest is simply ‘interest on interest’
Here’s an example;
If you invest £1000 every year for 30 years and received 5% interest on your money you will end up with just shy of £70,000. It doesn’t take a genius to work out that you have only contributed £30,000 of your own money, the rest is from the magic of compound interest.
Get rich slowly
Compound interest is by far and wide the easiest way to become wealthy. By making regular investments and reinvesting your gains over a long period, you let compounding do the ‘heavy lifting’.
Imagine you wanted to make the same £70,000 as in the graph above but you only had 10 years. You would need to contribute over £5000 of your own money every year!
Instead of only contributing £30,000 over 30 years you will need to put in £50,000 over 10 years!
Convinced that compounding is for you? Here is how to do it.
The trick to compounding is reinvesting your returns every single time you earn them.
If you earn interest on your cash in the bank, have the money deposited directly into the same account so you start earning money on it straight away.
For shares and funds, if available utilize the dividend/distribution reinvestment plan. This will automatically reinvest your dividend/distribution into the stock/fund it came from. It also saves you from paying broker fees.
If you can’t automatically reinvest or you have investments, like real estate which isn’t suitable for income reinvestment, deposit all of your investment earnings into a high-interest rate account until you have enough to make a new investment or contribution.
Remember it’s a marathon not a sprint
Compound interest is not a get rich quick scheme, but it can make you incredibly wealthy if you give it enough time.
If you drift back to your secondary school days you may recall your Maths teacher rambling on about something called ‘exponential growth/decay’; compound interest grows exponentially. It increases more and more each year, so the longer you leave the more it increases and the more you benefit.
You don’t need to be saving and investing large amounts to gain from compounding, you just need to make regular contributions and reinvest your earnings over a decent time period.
If you haven’t already seen the Seven Wonders of the World, make sure you are benefitting from the eighth; compound interest. It is one of the easiest ways to get wealthy, which one day will allow you to do all the sightseeing you like.
If you’re looking for more tips, tricks and advice on saving, investing and growing your wealth, download the Money Is Boring ebook today. Just click here to download for free.
Written by Brad Bevitt.