Albert Einstein said Compound Interest is “the 8th wonder of the world. He who understands it, earns it; he who doesn’t pays it.” This is a great quote about compounding interest. If you think about it hard the best and worst part about money is the compounding interest.
With a massive credit card debt with an interest rate of 22% or higher can really compound and make debt spiral out of control.
That interest will compound and double faster than you know it. On the other hand, if you have some great investments that are reaping 6-10% then your money will grow and grow.
“Compound Interest is the 8th wonder of the world. He who understands it, earns it; he who doesn't pays it.”
The Double Penny Story
So how can compounding interest double my income? That is a great question. I want to start off with a quick question.
Would you rather have a penny that doubles each day of the month or $1 million?
I have heard this question before, and most people without thinking would take $1 million dollars over the $0.01 doubling every day. Most people are all about instant gratification. Patience is a virtue (as my dad has always said). So let’s break down the numbers and think.
If you start off with one penny on day one, by day 3 it is 4 pennies, which is not so much. As it keeps doubling the amount becomes more.
Day 9: it becomes $2.56.
Day 13: It becomes $40.96. It keeps growing and doubling.
Day 21: That penny has now become $10,485.76. The $1 million still looks good doesn’t. There is still 9 more days left.
Day 24: $83,886.08
Day 26: $335,544.32
Day 28: $1.342.177.28
Day 30: $5,368,709.12
After 30 days, that single penny has doubled until it became $5,368,709.12. Now if it was me, I would take the doubling penny. I hope you would too.
The Power of Compound Interest
This doubling is all part of the power of compound interest. Compound interest is the interest upon interest.
Say you invest $1000 at 10%, you will then earn $100. The next year it would be $110 since it would be $1100. At 10% the money will not double as fast as the penny since the penny was doubling at 100% every single day.
The way people figure out how long it takes their money to grow is thinking about the Rule of 72
The Rule of 72
The Rule of 72 is an easy way to figure out how long it takes for an investment to double. Simply put:
Years to double = 72/interest rate.
Let’s take our example of the $1000 and 10% interest. With a 10% interest you have 72 divided by 10, which is 7.2. Your investment will double in 7 years.
Wow! Math rocks! Seriously, if you think about things like this you realize that math can help you figure out many things especially with money.
If you put an investment into a low interest rate the investment will not grow. The interest rates right now in America are historically low. The highest interest rates I have found with savings accounts are like 1%. That is a crazy low. It will take 72 years for your investment to double.
At the ripe age of 33, I am pretty sure I do not have 72 years left in my life. That puts me at 105.
One of the greatest things of investments is time. Time is the thing that will help your investments grow. If you look at the penny story, if we had stopped at 26, we may have never realized that we would have hit over $1 million at day 28.
The earlier you start investing the more time you will give that investment to grow. The more time you give the investment to grow, the larger the investment would become.
As I get older, I realize that there has been time wasted not investing. Listening to people about pensions and not thinking, reading, and discovering this information has stunted the growth of my investment future. As I keep learning, I keep finding it is better to start now than to wait.
“ The Best time to plant a tree was 20 years ago, the second best time is now”
Now is the time to start putting your money to do something, but where could that be.
“The Best time to plant a tree was 20 years ago, the second best time is now.”
Where to put your money?
Many people talk about investing in the stock market. Personally, I am a simple person that likes to use Index funds that track the total stock market like VTSAX.
Here is why I like the stock market.
Historically, the stock market has returned on average around 10% before inflation. Now that is not the case in every year.
The stock market can be volatile, and there can be ups and downs in the market.
Realistically you should not expect a return of 10%. An easier number would be something like 6-7%. The great thing is the market tends to always go up.
This 6-7% is based on what Warren Buffet expects. Since Warren Buffet is called the “greatest investor of all time.” He knows a thing or two about investing. He says this:
“The economy, as measured by gross domestic product, can be expected to grow at an annual rate of about 3 percent over the long term, and inflation of 2 percent would push nominal GDP growth to 5 percent,” Buffett said. “Stocks will probably rise at about that rate and dividend payments will boost total returns to 6 percent to 7 percent,”
As you can see the market will rise around 6-7% per year. This is not a bad percentage at all. It takes into account inflation, the rise and fall of business and gives us a realistic view of what your investment could do.
Many people put their money in the bank getting nothing in return. As this happens, inflation will devalue that money every year. It is better to put that money doing something like being invested in the stock market.
Invest Simply with M1 Finance. You can easily set up a simple portfolio and automate everything. Make life simpler.
People also like to put money into real estate. Real estate can be a place for some good investment values like through investment real estate, commercial real estate, or even REITs(Real Estate Investment Trusts). These are numerous ways people will invest in Real Estate.
I do not consider a primary residence as an investment mainly because you lack some of that tax implications from real estate such as tax write-offs due to maintenance, and maybe some of the numerous fees associated with buying and selling.
If you want you can also make plenty of money making a business. The Four Pillar Freedom blog, Zach talks about how he makes more websites and gets a better ROI (return of investment) off of websites than he does through the stock market
Compound Interest Doubling your Money.
There are a variety of ways to double your money. Compound Interest is the thing that gets that money rolling into the snowball that is your financial future. Before you get a thought about where to put your money ask yourself about how compound interest can help you achieve your goals.
” Spend less than you make, stay out of debt, and invest the rest”
I’m Steve. I’m an English Teacher, traveler, and an avid outdoorsman. If you’d like to comment, ask a question, or simply say hi, leave me a message here, on Twitter (@thefrugalexpat1). Many of my posts have been written to help those in their journey to financial independence. I am on my journey, and as I learn more I hope to share more. And as always, thanks for reading The Frugal Expat.