The Power of Compound Interest

The Power of Compound Interest

“Compound interest is the most powerful force in the universe” – Albert Einstein

While some may argue that this is a bit of an overstatement, there is no doubt that compound interest is a powerful force in determining your long-term wealth… or lack thereof.

In my last blog post, “Double your money faster with the Rule of 72“, I presented a few scenarios showing how important compound interest is when it comes to building wealth.  The post showed approximately how long it would take for three friends to double their money, based on the interest rate each was earning on their lump sum investment.  The results were dramatic!

For those who have a pile of money sitting around, “Double your money faster with the Rule of 72” may provide a powerful incentive to invest at the best rate of return that their risk tolerance will allow.  Who doesn’t want to double their money faster?

But what about those who can only afford to invest a bit at a time?  Will the power of compound interest still work its magic?  ABSOLUTELY!!!  The key is to start NOW!!!

Even before I learned how money works, I had heard that it’s important to start saving early.  But how?  When you’re a young adult, setting aside savings often takes a backseat to school and getting established out on your own.  For those who live in places like Vancouver, where the cost of living is very high, it’s easy to go through most of your 20′s unable to save.  It’s also easy to start closing in on 30 with a bit more money in your pocket, but also a feeling of discouragement in the pit of your stomach.  Many try to alleviate this feeling by throwing away their hard-earned “disposable” income on frequent dining out, overpriced (yet beautiful!) shoes, the latest tech gadgets, and other forms of “retail therapy”.  (I know I did!)

A real eye-opener for me was seeing how much money I could end up with by the time I retired.  I could either keep throwing my money away, and find myself in retirement living CPP cheque to CPP cheque, or I could follow a simple plan to rescue my financial future.

The simple plan:  Start saving $200 a month (Age 30-65)

The goal: Become a millionaire.

Seriously!  If you’re laughing, STOP.  JUST READ.  It IS possible… thanks to the power of  compound interest!*

By setting aside $200 a month for 35 years, it is possible to build up a sizable retirement nest egg.  As we’ve seen in my previous blog post, the higher the rate of return, the quicker money doubles.  This means that over 35 years, money invested at a higher rate of return will double more times than at a lower rate of return.

Here’s what this mean in dollars and cents*:

3% interest – $148,680

6% interest – $286,370

12% interest – $1.3 MILLION

When I first saw this example, my eyes bugged out.  I was astounded by how much I could make by saving money I had been throwing away on stuff I didn’t really need.  The light switch suddenly flipped on, illuminating my  financial future.  I hope by learning the importance of compound interest that you, too, can have a brighter financial future.

Have questions on how compound interest can work for you?  Feel free to comment below, or direct message me on Twitter @KnowMoneyCA

*Figures based on investing $200 per month from the ages of 30-65, with a consistent rate of return during the 35 year period.  Hypothetical examples are used only to illustrate the effects of the compound growth rate and are not indicative of a guaranteed rate of return on any investment and not intended to demonstrate the performance of any actual investment. Unlike actual investments, the illustrations use a constant rate of return of 3, 6, 12% without and fees or charges.  Rates of return are nominal rates, compounded monthly.  Contributions are assumed to be made at the beginning of the month.  It does not take into consideration taxes or other applicable deductions.

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3 Responses to “The Power of Compound Interest”

  1. Again, great post! I’m learning a lot here. Keep up the great work! Looking forward to subsequent posts!

  2. [...] Know your money revisites one of the most powerful financial concepts – the power of compound interest [...]

  3. [...] Know your money revisites one of the most powerful financial concepts – the power of compound interest [...]

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