Compound Interest is the best kept secret of the super wealthy. Whenever you hear a rich person saying that you should “make your money work for you” and not “work for your money” they mean compound interest.
These rich people are earning interest on their interest. And, no, that’s not a typo. I’m going to create a simple example and explanation. Mainly because I want something to link to in my posts whenever I mention compound interest.
Compound Interest Vs. Simple Interest
Let’s say you bought a $10,000 treasury bond that paid you 3% annually and matured in 10 year. This means that you would get $300 per year until the bond matured and you got your original $10,000 back. That’s known as Simple Interest
Compound Interest, on the other hand, works much differently. There are plenty of different types of compound interest investments, and I’ll get to those in a minute. For now, let’s see what happens if that $10,000 earning 3% interest was a compound interest investment.
At the first year, you would have that same $300. Your new balance would be $10,300. On year two, you would earn $309. Your new balance would be $10,609. And here comes the third year where you earn $318.27 to give you a balance of $10,927.27. Year 4 you would earn $327.82 in interest.
Imagine that on a much larger scale now. $10,000,000 = $300,000 per year.
Also, a multi-million dollar investment is going to see returns of much more than 3%.
Speaking of interest rates: You should refinance your mortgage before they find a cure to Covid-19
Power Of 72: Compound Interest Doubling
When that interest is compounded annually, your money is guaranteed to double after so many years (I’ll show you how to calculate that in a second). If you divide 72 by whatever your return rate is, it should tell you how long until your money doubles.
Over a certain period of time (multiple years, not months), it’s not impossible to earn 8%-10% interest in investments. Let’s go with 10% because it’s a nice round number and it’ll make the examples a lot easier.
72 divided by 10 is 7.2. So an investment earning compound interest with an annual return of 10% is going to double in size every 7.2 years.
Rich people LOVE setting up trust funds for their kids. Let’s look at an example fund set aside for some stupid rich kid that we’re all jealous of already even though this is hypothetical and he’s not even real. Let’s say this nonexistent kid’s fund will earn 10%
Imagine setting aside $2 Million for a newborn. When they’re a little over 7 years old it’s not $4 Million. Sometime around age 14-15 it’s now $8 Million. By the time they’re an adult, that fund is now $16 million. And that’s without adding any more money to it whatsoever. That’s straight compound interest.
This is how the rich get richer, and how their money can seemingly grow from nowhere.
Regular People Can Get Rich From $100 Per Week
… it just takes a lot longer. If you’re reading this and you’re in your mid 20’s or younger, it will be fairly easy for you to retire as a millionaire thanks to the power of compound interest.
Using the investor.gov Compound Interest Calculator, let’s look at two Compound Interest Examples:
Example #1: At the time of your birth, your parents put $10,000 into something like an index fund that traditionally earns 9% over time. If you did not touch that money whatsoever, then by the time you hit retirement age of 62, that $10,000 will have grown to be worth well over $2 Million. And that’s with no added contributions.
Example #2: You’re in your mid-20’s and you’ve just landed your first big-boy job. You set aside $2,000 into a retirement fund and contribute $100 per week to this fund. By the time you hit 50 years old, your fund should be worth nearly half a million bucks. By the time you hit retirement age of 62, you’ll be looking at well over $1.28 Million.
Seriously, if you’re young enough and can spare $14.28 per day, then you can retire as a millionaire. If your company has 401K contribution matching then you’ll likely edge closer to the multi-millionaire range for retirement.
Types Of Compound Interest Investments:
Believe it or not, most investment types will compound interest.
If you buy stock in AAPL and that stock price rises, your interest is being compounded.
If you put your money into a high-yield savings account, that interest is compounded.
There are some investments, ilke eREITs (real-estate investments.. That’s another topic for another day) whereby your interest might be compounded a few times per year. And, if your interest is compounded more frequently, then you can earn a lower rate and still make more money.
You’ve made it to the end! If you’re new here, my name is Brad. You might be interested in reading my story. I post financial advice, money-making tips, and some funny prison stories. Subscribe to get updates when I post something new. I’ll never spam you.