Before saying anything, you should take note that compound interest is far from any get-rich-quick scheme.
If you plan to earn quick bucks, this isn’t going to help with that. But if you’ve ever thought about building generational wealth or would like to know the possibilities of that happening?
You are in the right place, let’s get the ball rolling.
Making and spending money, along with various obligations take chief priority in our day to day lives, but most of us have very little knowledge concerning what could be done with money after satisfying mandatory expenses and desires(other than saving).
Virtually everyone that has had any form of education has heard for compound interest, I know I have. Then, it was just another problem that was present as a result of mathematics being in the curriculum.
Growing up, most of us used to question the future value of studying some topics in mathematics.
After learning what I currently know about compound interest, it has been fully exonerated.
This post will not be about teaching you, but showing you the power of compound interest.
Compound interest is defined as the interest on a deposit or loan calculated based on the initial principal (starting balance) and the accumulated interest(daily/monthly/yearly) from previous periods(times).
It can either be your best friend or your worst enemy. A quote by Albert Einstein goes thus:
“Compound interest is the 8th wonder of the world. He understands it, earns it, he who doesn’t, pays it”.
To EARN compound interest, you must invest capital.
To PAY compound interest, you must be in debt. Which in the real sense means you’re paying the compound interest on another person’s capital.
Example of Compound interest
Let us consider making an investment of 100,000 monthly for 10years with an interest rate of 11% and see how interest is compounded enormously.
While taking a look (at total deposits and balance),
Notice how the interests accumulated caused gains in millions over the 5th, 6th, 7th, 8th, 9th, and 10th years.
The interest compounded over those periods was responsible for the doubling effect seen when comparing the final total deposits with balance.
|Year Deposits||Year Interests|
How to make Compound interest WORK
Some important things to take note of include:
- Time and Duration
- Interest rate VS Inflation rate
Time and Duration
Let’s say two people John and Jude decide to invest their money in the capital market (mutual fund/ equity/ money market etc).
John invests 2000 per month,
Jude invests 700 per month
Just looking at the figures, John should have more money at the end… but there is one difference.
John started investing at age 40-60(20 years)
Jude started investing at age 25-60(35years).
Both John and Jude finally reached 60years old, both invested in the same product. Having the same interest rate of 8%.
Their portfolio looks like this,
John has 1,178,040
Jude has 1,386,329
In summary, John invested more than Jude did but came out short due to having a shorter duration of investment.
To further blow your mind, at the age of 60 John had invested a total amount of 480,000 of the 1,178,040 (690,040 gained through compound interest).
Meanwhile, at the age of 60, Jude had invested a total amount of 252,000 from his own money out of the 1,376,329 (1,124,329 gained through compound interest) which he realized.
This is what makes time and duration an important factor in compound interest.
Interest rate VS Inflation rate
The inflation rate is a silent thief when it comes to money. It slowly and invincibly drains its worth.
When the inflation rate is falling, your money is worth more.
When the inflation rate is on the rise, your money is worth less.
The only way to beat rising inflation is to tie (not literally) your money to something of rising value.
For example, if there is an inflation rate of 5% and you invest your money into a government bond that promises a 4% return on investment yearly, you lose 1% of the value of money invested yearly.
On the contrary, if there is an inflation rate of 5% and you invest your money into a that promises an 8% return on investment yearly, you gain 3% of the value of money invested yearly.
This is how you use interest rates to tilt the odds of positive compound interest in your favor.
Consistency is the most important determining factor of your compound interest. But this is also where most people “fumble” the process.
To stay consistent with investments, it is expected that the amount of investment monthly or yearly is well within your capabilities. Compound interest favors everyone at the end but without consistency, there is no compound interest.
“When you get compound interest working FOR you, you give it TIME to get to work. Your money works even HARDER for you.”