Understanding Compound Interest


Want to retire a millionaire, or be able to pay for your kid’s college, then start now! I am talking about a realistic outcome that will inevitably set you apart from your peers in the years to come. I am speaking about compound interest, and it just happens to be an investor’s best friend. Albert Einstein said, “Compound interest is the eighth wonder of the world. He who understands it, earns it… he who doesn’t… pays it.”

Compound interest is why you pay the bank $171,869.51 on a house that you are buying for $100,000 with a 4% interest rate for 30 years. The ability to take advantage of this opportunity is at the very fingertips of every single individual. It’s simply making money with your money. Let me break this down in a more transparent form. Let’s say – hypothetically – every month you set aside $100 dollars that you have budgeted. At the end of the year you have $1200 dollars. You place that $1200 into a fund that earns conservatively 6% interest on average. While this is seemingly low, please keep in mind that we are being conservative in our example. It’s important that you walk away with the basic understanding of how this works.

EX: 1200 a year ($100 dollars a month) x 6% interest per year

1st year we have 1200 x 6% = 72; 1200 + 72 = $ 1,272

2nd year we have 1272 + 1200 = 2472; 2472 x 6% = 148.32; 2472 + 148.32 = $2,620.32

You have put in a total of 1200 (a year) x 10 (years) = $12,000, but end up with $26,722.40 after just 18 years. Now imagine that goes on for the next 22 years or 32 years; whenever you want to retire, what do you think it will look like? Also, that’s at a conservative 6% interest rate; what if you received a 10% or 12% interest rate? What if you were able to continue to put that $100 (mo.) into it, or even put a little extra in each year? All of this encompasses the beauty of compound interest, and making your money work for you. That’s why it is imperative that you start now, because the sooner you start, the more you’ll have. To give yourself a better idea of what your own numbers will look like, or to be able to figure out your personal plan, I suggest using the website Investor.gov.

Now…

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