Have you ever wished that you could have more money, without all the effort? Or are you concerned you won’t have enough saved for retirement or your child’s education? Luckily, there’s actually a simple way to accomplish those things if you’re willing to learn how to put your money to work for you. It’s called compound interest.
When people think of interest, they often think of debt. But interest can work in your favor when you’re earning it on money you’ve saved or invested. Compound interest is the principle by which your interest earns interest. And then that interest earns you interest and it goes on and on. As your balance gets larger, your interest payments grow larger, and ultimately your money grows even faster. Think of it like a snowflake turning into a giant snowball — the longer the hill is, the bigger the snowball can get.
“Compound interest is the 8th wonder of the world. He who understands it, earns it; he who doesn’t, pays it.”Albert Einstein
The magic ingredient that makes compound interest work best is time. Compounding happens when interest is paid repeatedly. The first one or two cycles are not especially impressive, but things start to pick up after you add interest over and over again. Thus, compounding becomes more dramatic over longer periods. The simple fact is that when you start investing outweighs how much you invest.
The longer you can leave your money untouched, the greater it can grow since compound interest grows exponentially over time. Every dollar you add to your balance creates a little more interest, and every bit of interest builds up your balance even more.
Two friends start investing, Noor starts investing $6,000 a year at the age of 25, and Yasmine starts investing the same amount at the age of 35. They both retire at 65. This will translate to a difference of over $300,000 between the two. This is the magic of compounding and the importance of starting as soon as possible (see graph below).
If you want to easily accumulate wealth and take advantage of the magic of compound interest, it’s important to start early and be consistent. As you can see in the example above, it’s possible for your money to grow to a large sum with a small initial investment. If you consistently save and invest, you’ll have a large sum of money by the time you retire. The key is starting early and contributing what you can! It may seem like it’s not worth it, but even small contributions add up over time.