Compound interest is the process of putting your money to work to make more money, without any added effort on your part (like going to your job). For it to work, it needs two things: It needs your money that you earn to be reinvested, and…father time. Compound interest is the best thing since sliced bread. It allows your money to grow exponentially (no limit). If you’re young and have time on your side, you have a huge advantage. Let’s look at a couple examples.
- 1. Investing 101: Introduction
- 2. Investing 101: What is Investing Anyways?
- 3. Investing 101: Understanding Compound Interest
- 4. Investing 101: The Myths of Investing
- 5. Investing 101: Investing and Technology
First, A Story
Way back in the year 1626, it’s widely believed that Dutch traders paid the Native Americans $24 for the entire island of Manhattan (New York).
Now most people would probably have a problem with that, and rightly so. I mean how could those sneaky traders do something so underhanded!? Well, hold on there cowboy, we’re talking about compound interest here, after all.
What if, after being paid for the Island, the Native Americans came together and appointed an investment manager from among themselves to handle their new found wealth. Say he or she was able to find investments that gave a 7% return year after year. Seems pretty doable, right?
Here’s the kicker: that $24 today, compounded at a respectable 7% return with no additional capital added (and none taken out), would be worth $14 trillion…with a ‘T’.
The entire U.S. GDP in 2016 was 18 trillion.
So the next question would be: Is the combined real estate of the island of Manhattan worth almost 80% of 2016’s U.S. GDP?
The United States has a massive and incredibly diverse economy, so it’s highly doubtful. In this case, compound interest wins.
It’s Powerful, So Start Early
Say you’re 21 years old, if you want to retire with $1 million by the age of 60 you’ll need to save roughly $330/month assuming an 8% rate of compound interest.
If you’re 31 you’ll need $750/month.
41 you’ll need $2,000/month.
51 you’ll need $6,250/month. Ouch.
The parable of the story? Start early.
Now here’s where it gets really wild, what if you could average 10%? Or 15%? What then? Ooooh baby, glad you asked:
That 21 year old ends up with a cool $7 million at age 60 with no change in savings.
Our 31 year old is $4 million richer.
41 has $2.5 million in the bank.
51 has $1.5 million at age 60….
Then there’s this guy named Warren Buffett, he averaged 25%+ return…for. 70. Years.
*smack* I think that was your jaw hitting the floor.
$10,000 invested in Wal-Mart in 1980, with no additional money invested, is now worth close to $7 million. That’s about a 18% return. Wal-Mart is a company a lot of people can understand and wrap their heads around and is exactly the type of company I hope you’ll learn how to identify and invest in over time.
Learning to invest in individual stocks now your thing? No problem! Compounding works with Index funds too!
Investing in the S&P 500 gave you an 8% return since 1993: $10,000 is now $55,000, nothing to sneeze at. And this is with ZERO effort, literally set and forget.
With a little “tending of the garden” this 8% can be bumped up to 10-12% fairly easily, which I’ll explain later.
The main takeaway here is for you to have a sense of urgency about starting now. The longer you procrastinate, the harder it’ll be for yourself, both to learn and to save enough for your lifestyle goals.