When it comes to investment there is one powerful force. When used appropriately and with patience it can unlock a future for many that is thought impossible. That force of investment is compound interest. Stick around to learn a thing or two about how you can benefit from getting in early and investing your way to compounding financial gain.
What Is Compounding?
A simple way to define compounding is to state that it is the mathematical process of earning interest on interest. That may seem confusing but let’s look at an example:
An investor rolls $10,000 into a savings account and earns 10% per year. After the first year the investor has rolled $10,000 + $1,000 = $11,000 in savings. The investor then earns 10% on that new total, or $1,100. This is where compound interest starts to take shape. At the end of the second year the independent has $11,000 + $1,100 = $12,100. So you see that our little investor has earned an additional $100 for doing nothing but depositing money into a savings account.
Is Compound Interest Really That Simple?
You may be thinking it’s too good to be true but it’s completely realistic. The beauty of compound interest means that the more time you give it the more powerful it becomes. To illustrate this point let’s return to our investor who started with $10,000 and earned $1,100 in interest after two years. But this time let’s change the equation so that our investor deposits $2,000 each year instead of $10,000 all at once. After the first year our investor has $10,000 + $2,000 = $12,000. After the second year our investor has $12,000 + $2,200 = $14,200. So you see that this time around our investor’s gained an extra $800 instead of just $100. The great thing about compound interest is that it accelerates as time passes.
Why Should You Invest?
“Investing is a long term process. The sooner you start that process the more you can build your wealth.”
You may be thinking that this may be a bit too good to be true. The truth is that many people don’t even look at compound interest when it comes to investing. Why? Their thinking may sound something like this: “I could probably find a better way to invest my money.” This is where it gets tricky. There are thousands of possible investing options whether it’s by putting it in the bank, buying stocks or joining an investment club.
How to Take Advantage of Compounding?
Start early in your life . Some say that the best time to begin investing is in your early 20’s. Why? The younger you are the more time compound interest has available to grow your money. Think of it like this: If you invested $1,000 at age 25 and let it grow at 10% per year for 40 years you would end up with $35,832.10*. But if you put off investing until age 45 and let it grow for 30 years you would end up with $11,411.14.
Other Types Of Investment:
Dollar Cost Averaging: This is a popular investing strategy that involves buying an amount of an investment at regular intervals. For example, if you are being paid $10,000 per year you would use your entire paycheck to buy $1,000 worth of stock per month. Then the entire year’s worth of dividends would be reinvested. This strategy helps with job security is effective for conservative investors with long term investment strategies.
Real Estate Yields: Real estate is one of the best types of investment for compound interest. Just because an investment is real estate doesn’t mean you have to buy a house. Many people buy rental property and let it grow. The important thing to remember here is that rental properties that are purchased through the use of a mortgage not only earn mortgage interest but also rental income and gains on sale.
Retirement Income: The word retirement can make many people fear investing in their old age or even before they retire from their career. But if you can afford to make a substantial investment then it will be well worth the time and money that you invest. So how much should you invest? It all depends on your goals. You may want to continue as a part of the workforce as some people do, some may want to pursue other business endeavors like writing books or pursuing politics. Whatever your goal is there are retirement vehicles for you.
