As Albert Einstein said – “Compound Interest is the the eighth wonder of the world.”
Read on to find out what exactly compound interest is, and why it is pretty important.
When you understand compound interest, you can use it to build up your wealth.
So what exactly is compound interest?
You may have come across compound interest in your school Maths lessons, so lets take a quick and simple recap…
A great way to understand compound interest is to relate it to building a snowman:
- When you start rolling the snowball, at first, the growth will be slow. However overtime as the snowball surface area gets larger, it will be able to pick up more snow.
- It may take 6 minutes to first double in size, but just 4 minutes to double again and then 1 minute to double for a third time.
And now lets relate this to wealth building – at the beginning of your investment journey, your returns will seem small. However overtime through consistently investing and over the years, this compounding effect will play a greater roll and increase your growth at a quicker rate.
Due to compound interest it does not matter how much you invest, but when you start – as it will provide a longer timeframe to allow your money to grow. The earlier you start, the better!
As an investor, why does this matter to me?
Compound interest will not only work on the returns you can potentially make from your investments, but also on your deposits!
Long-term stock market investors can expect an annual average return of 8 – 10%, but do note you may not see this return every year. The rate of return depends on what you are invested in.
The number one skill you need to have in order to get the benefits of compounding is patience. Compound interest will not make you a millionaire overnight. Earning compound interest is about as exciting as watching paint dry on a wall or grass grow in your lawn. However, it is crucial if you want to experience growth in wealth over your lifetime to be patient and start as soon as you can.
How to work out compound interest …
Compound interest calculators provide a great way to find out how compound interest will impact your investment portfolio.
They often have sections for you to fill in such as:
- Initial deposit (aka how much money, if any, you hold in your investment portfolio)
- Contributions – how much you think you will contribute on a monthly, or weekly basis
- Investment life span – you can so how much your investments will look like in any amount of years , such as 5,10, 20, 35 etc years from now
- Rate of return – just like investment life span, you can play around with this to base your figure on a range of return rate, such as 7,8 or 10%
Some of my favourite compound interest calculators are:
Play around with these calculators, to see how compound interest works and how much your investment could grow over time with regular contributions.
Compound interest shows the importance of starting to invest sooner than later, no matter how much you are able to set aside.
Combine patience, investing consistently and compound interest – investing can be an incredible wealth building tool.