Compounding is the simple, easy and same process of multiplying money to create magical growth in anything applied. Yes, anything applied. And, what can be better than applying it in your finances.
Today, we explore the magical power of Compound Interest to growing your wealth.
Albert Einstein said, “Compound interest is the eighth wonder of the world. He who understands it, earns it; he who doesn’t, pays it.”
What is Compound Interest?
Compound interest is the process of earning interest over interest over a period of time. Unlike simple interest, it is a process of reinvesting the interests over a period of time to magically grow your wealth.
If you invest $1,000 with a 10% annual interest, you will get $100 in interest the first year which is reinvested for interest on $1100 (principle amount + first year’s interest) the second year. It grows to $1210 the third year. This way it creates a snowball effect and multiplies your money exponentially.
How Does Compound Interest Work?
The formula for compound interest is:
A = P (1 + r/n)^(n*t)
A: Final Amount
P: Principal Amount
r: Annual Interest Rate (decimal form)
n: Number Of Compounding Periods Per Year
t: Time In Years
For instance, if you invest $1,000 at 5% annual interest rate for 10 years, you’ll end up with $1,628.89. The faster the interest is compounded, the faster the money grows.
Benefits of Compound Interest
There are many benefits of compound interest but the best one is that it grows your money exponentially.
It also works passively as the interest gained is reinvested for compounded interest.
Compound Interest provides long-term financial security. It encourage early investing because the early you set up your money in the machine of compound interest, the more benefit you can get from it.
The Power of Starting Early
Warren Buffett invested for the first time at the age of 11 years, but he still says he started investing very late just because he knows the power of compounding.
Time and the frequency of compounding is the most critical factor of compound interest.
Let’s understand this with an easy example:
Investor A: Let, investor A invest $5,000 annually from age 25 to 35 (10 years) and stops.
Investor B: Let, Investor B invest $5,000 annually from age 35 to 65 (30 years) and stops.
Here, Investor B invested for the longer period of time but Investor A makes the larger amount of money at last because of the early investment done.
Why Compound Interest is Key to Financial Freedom
Compound interest, the eighth wonder of the world, is the key to financial freedom. Job and savings can’t make you financially free but when they are compounded with compounded investing, it will.
It is the strategy used by many millionaires.
Start today, stay disciplined and let the magic of compound interest turn your financial dreams into reality.