How to Accelerate Your Savings With the Power of Compound Interest
Here's the secret behind the eighth wonder of the world.
Many people believe simply saving money in the bank is the safest way to grow their wealth.
But with inflation at elevated levels of 3% and base bank interest rates hovering at just 0.05% per annum, you are actually losing money by letting your money sit in the bank.
So, how can you make your money work for you and outpace inflation? Investing is the key.
The Magic of Compound Interest
Albert Einstein is said to have called compound interest "the eighth wonder of the world."
Compound interest is interest earned on both your initial investment and the accumulated interest over time. This means your money grows at an accelerated rate compared to simple interest.
The beauty of compound interest is that the earlier you start investing, the more time your money has to grow. Here's a powerful example.
Investor A vs. Investor B
Imagine two people: Investor A and Investor B. Investor A starts investing $2,000 annually at age 19 and stops after seven years, totaling $14,000 invested. Investor B starts later, at age 26, but invests $2,000 annually until 65, totaling $80,000 invested.
Assuming a 10% annual return, you might think Investor B would have the bigger nest egg at retirement. They did contribute more money after all. But here's the twist:
Investor A's portfolio would be worth $944,641.
Investor B's portfolio would be worth $973,704.
While Investor B has a larger total investment, Investor A's money had more time to compound, resulting in higher net earnings of $930,641 compared to Investor B's $893,704. This highlights the incredible power of starting early!
The Power of Time
I got the above example from one of the Dow Theory Letters, entitled Rich Man, Poor Man.
The Dow Theory mentioned the following about compounding (emphases mine):
“Compounding is the royal road to riches. Compounding is the safe road, the sure road, and fortunately, anybody can do it. To compound successfully you need the following: perseverance in order to keep you firmly on the savings path. You need intelligence in order to understand what you are doing and why. And you need a knowledge of the mathematics tables in order to comprehend the amazing rewards that will come to you if you faithfully follow the compounding road. And, of course, you need time, time to allow the power of compounding to work for you. Remember, compounding only works through time.”
Time certainly helps to accelerate the growth of our money. For the math geeks, here’s the formula for compound interest (to make things simple, we will assume compounding is done annually):
A = P × (1+r)t
where A = Amount accumulated; P = Principal amount (or initial investment); r = annual interest rate; t = number of years
As you can see, the longer the period, t, more time there is for compounding to do its magic, creating a larger ending amount, A.
Now you know why everyone should start investing as early as possible.
Investing Is for Everyone
Investing isn't just for the wealthy. It's a powerful tool anyone can use to build wealth and secure their financial future. Here at The Compounding Dad, we believe in the power of long-term investing and the magic of compound interest. With compound interest, your money makes money and the money your money makes makes more money.
Ready to Take Charge?
The best time to invest is now! The next best time was yesterday. Stay tuned for more from The Compounding Dad as we navigate the world of investing together!