Compound Interest Will Make You Wealthy

By Floyd Saunders, Author of Five Paths to Wealth, available from Amazon

Extracted from Five Paths to Wealth, available on Amazon

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Compound interest has been called the eighth wonder of the world (Albert Einstein is credited with saying that).

Why? Because it magically turns a little bit of money, invested wisely, into a whole lot of cash. Even Albert Einstein, when asked to name the greatest invention in human history was purported to have simply said “compound interest”. Start saving just 10% of what you earn and when it is properly invested, in a few years you will see how this can work for you to build the financial security you need.

Here is What You Need to Know about Compound Interest

Compound interest might seen like the most boring thing in the world. If you take a dollar and invested with a 10% return, that dollar is only worth $1.10 at the end of the year (assuming one interest payment). Invest that $1.10 and get 10% again, and you'll end up with $1.21 two years from your original investment.

The first year earned you only $0.10, but the second generated $0.11. Those extra few cents is free money. This is compounding of interest at its most basic level: simple gains get you more simple gains. An illustration of how this works might help:

Let’s say Betty, at 20 years of age started by investing $1,000 today. Now if she didn’t touch it until age 70, her money would increase by 32 times — meaning she could end up with around $32,000. (with a 7.2 percent growth rate, which is reasonable based on the historical, long-term returns of U.S. large-cap stocks.)

But what happens if Betty waited until she was 30 to invest that $1,000 and leave it be until retirement? With less time to compound returns Betty will have half as much, just $16,000.

Now if Betty was to invest $1,000 at age 20 and contribute $83 a month (around $1,000 a year) until retirement, she’d have $465,000.

If she did the same but waited to start until 30, she’d end up with about $225,000 — and if it were age 40, she’d have about $105,000.

You need two things to harness this great invention, time and just a little bit of money.

You see when you save or invest your money earns interest or appreciates. If your money compounds on an annual basis, you earn interest on your original money and the interest from the first year, in the second year. In the third year, you earn interest on your original money and the interest from the first two years. And so on. Great investors have learned the value of compound interest, Warren Buffett for example has said: "My wealth has come from a combination of living in America, some lucky genes, and compound interest."

This works equally as well with dividends reinvested from owning stocks. As an investor you don't want to overlook the value of compounding your returns into bigger returns year after year. This is why you want to start an early as possible to allow time to make the magic of compounding really work for you.

When you were a kid, perhaps one of your friends asked you the following trick question: "Would you rather have $10,000 per day for 30 days or a penny that doubled in value every day for 30 days?" Today, we know to choose the doubling penny, because at the end of 30 days, we'd have about $5 million versus the $300,000 we'd have if we chose $10,000 per day.

Compound interest is often called the eighth wonder of the world, because it seems to possess magical powers, like turning a penny into $5 million. The great part about compound interest is that it applies to money, and it helps us to achieve our financial goals, such as becoming a millionaire, retiring comfortably, or being financially independent.

The answer then to take advantage of compounding returns is to start early and invest something every month in a good investment product returning just the average of he stock market. An exchanged traded fund that invests in the S&P 500 is a good option.

Just follow the advice from famed investor Warren Buffett “For most people, the best thing to do is to own the S&P 500 index fund.”

You can learn more about compound interest and investing by reading Five Simple Paths to Wealth. Available now from Amazon.