One of the keys to building wealth, compound interest is one of the most powerful concepts in personal finance. But, what do we mean by “the power of compound interest” and what exactly is compound interest? Simply put, it’s earning interest on interest. Sound confusing? Once you get the hang of it, it’s actually quite easy to understand.
Here is how it works. When you make an initial investment, your principal starts accruing interest. As you earn interest, the account balance grows. Over time, you continue to earn interest on the
growing balance, as opposed to simple interest which is tied to the initial investment. This leads to the exponential growth of your investments long-term, hence the power of compound interest. Principal, the amount of money initially invested begins the process. Next, the interest rate (fixed or variable) adds to the principle. Know for the compounding period. Daily, monthly, or annually, this determines when a new base is established on which interest is applied. Of course, the final element is time. The longer this process is given, the greater your balance. From this explanation , you can appreciate why Albert Einstein called compound interest the “eighth wonder of the world”. It is one of the most important parts of wealth building.
Compounding interest in action using a common example of paying down debt and missing the benefit of compound interest: Let’s assume that you can save $1,000/mo. for the next 40 years. Let’s assume we can earn 8% on that money. How much is that bucket of money worth after 40 years. $3.1M! that’s an incredible amount of money. But now let’s assume that instead of saving we’re going to pay down debt with that $1,000/mo. Let’s assume we focus on debt for the next 5 years and we start saving after that. We now have 35 years to save $1,000/mo. rather than 40 years. How much do we have now? About $2.1M. That means that waiting just 5 years is going to cost you $1M!
The bottom line: Compound interest is available to everyone but you have to save in order to benefit. The earlier you start saving, the more exponential growth can occur. Best of all, it’s never too late. You can harness the power of compound interest at any time. Talk to us today and learn how our professionals can help you take advantage of compound interest and growing your wealth.