Are you looking for a way to stack your future investments without doing too much work or putting in too much effort? Compounding interest may be the answer you’ve been looking for. This is the way the rich stay rich or those who are looking to get a rich start off, by rapidly growing your wealth.
First, what is compounding interest? It’s what it sounds like, earning interest on your interest. Put more simply this is a way of calculating interest whereby all the interest you earn over time is added to the principal sum. Where you will earn interest on the principal but also interest on that interest. This happens when you save your interest rather than taking it out.
How does your interest work for you?
This concept sees your savings or investments grow exponentially over time, this can also help you visualize your future value with a simple formula. If you are not persuaded just yet, take this as an example. You have $10,000 to invest and you have done so for 10-years. The annual return on average is 5% throughout, each year your earnings grow through compounding, without you adding any additional funds.
| Year | Beginning of Year Value | Yearly Earnings | End of Year Value |
|---|---|---|---|
| 1 | $10,000 | $500 | $10,500 |
| 2 | $10,500 | $525 | $11,025 |
| 3 | $11,025 | $551.25 | $11,576.25 |
| 4 | $11,576.25 | $578.82 | $12,155.06 |
| 5 | $12,155.06 | $607.75 | $12,762.81 |
| 6 | $12,762.81 | $638.14 | $13,400.95 |
| 7 | $13,400.95 | $670.05 | $14,071 |
| 8 | $14,071 | $703.55 | $14,774.55 |
| 9 | $14,774.55 | $738.73 | $15,513.28 |
| 10 | $15,513.28 | $775.66 | $16,288.95 |
In 10-years, without having done anything, your investment has grown by 63%. You have seen the yearly earnings grow as well due to the interest paid on the interest.
Use the compound interest formula to calculate your Future Value!
The compound interest formula is very simple. It is as follows.
How to get rich with compound interest (3-Tips)
The secret of building wealth is to save money and invest in a timely manner so you give your money a chance to build wealth for you. You need to have a financial plan in place so you know how much you’re able to put away for this purpose on a weekly or monthly basis.
The earlier the better
Interest growing and creating wealth doesn’t happen quickly, the earlier stages of the process are slow and you want to give the investment time to play out and build. It’s essential to get into the savings and investing mindset to grow your interest early. Work hard at the beginning of your life, because millionaires are usually made in their 20s and 30s rather than their 50s and 60s, said Fred Creutzer, president of Creutzer Financial Services. At 50 you can’t catch someone that starts at 20.
Take a look at the diagram above. We assume that there are 4 age groups so we can compare between them and how much money they need to invest on a monthly basis to get to $1 million by age 65 and retirement. Naturally, this is just a scenario, and investing/saving may not be this linear.
In the first scenario, we have an individual age 20, that has to invest $425 every month to get to their goal in 45 years. The compound interest takes care of the rest. This is a little aggressive, not many 20-year-olds are able to put aside $425/monthly. There is a lot that can, however! In this case, this young adult would have invested $229,500. The rest, nearly $774,000 all-in interest! Naturally the more you develop throughout your life, the more money you will contribute so that $1,000,000 will come sooner than expected.
Compared to the 30-year old who has to invest nearly 2 times more than the 20-year old to meet that goal, the rest of the age groups look scary. Saving and investing more than $1,000 on a monthly basis let alone over $3,500 to reach those goals is a little extended. Meaning it’s a lot easier when you start earlier and you make those smaller contributions!
Invest/Save within your means!
Everyone wants to get to their goal faster, there’s no need to invest or save more money than you can afford. This is why we need to have a financial budget set in play so you can invest according to your income. As you progress in your field and career you will be able to add more to your goal. You don’t want to be struggling in your current daily life to reach your long term goal.
Do not be worried if you don’t have a lot to start with, if you are in your early 20s and you are thinking about this and taking action to make it happen, you are far ahead of the rest. Even just a few hundred dollars a month you will see incredible growth. In the earlier example, we had an investor that threw in $10,000 into a 10-year growth project that grew at 5.50% annually without any contributions. The account still grew well, however in comparison to someone that contributes a few hundred dollars a month the gains were incomparable.
Patience is a virtue
This strategy and process will not happen overnight and it will take years. This is not an active strategy, and it’s never about timing the market, it’s about time in the market. Timing the market is usually extremely difficult. Instead focus on strong assets that have a long future ahead of them, even though this is hard to predict in itself. As long as its a strong company, the economy will consistently improve and so will the market. The Warren Buffett strategy, buy and hold, find companies that pay dividends which you can either reinvest or use as income. Your patience will be rewarded, when you give your money time to grow and compound you will see the large benefits and more likely to hit your goal.
Conclusion:
Compound interest is a great tool not only for investors but also for all! If you take control of your financial freedom and your retirement. Make your money work for you! TRADEPRO Academy offers futures education and a live trading room where you can interact with the top mentors to better your futures trading.
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The information contained in this post is solely for educational purposes and does not constitute investment advice. The risk of trading in securities markets can be substantial. You should carefully consider if engaging in such activity is suitable for your own financial situation. TRADEPRO Academy is not responsible for any liabilities arising as a result of your market involvement or individual trade activities.
