Wealth-Building Power Math: Compound Interest (Part 1)

May 3

Image sourced by **Jp Valery @jpvalery**

How to Build Mountains of Wealth, While You Sleep!

One of the very best ways to build wealth is to capture the power of Compound Interest and Compound Returns.

Interestingly enough, many people often overlook this amazing wealth-building technique.

Compound interest means earning interest on interest.

With this often-overlooked power tool, you can turn a few dollars into hundreds of thousands and earn money while you sleep!

The secret is to:

Make an investment plan based on your financial goals
Invest your money and reinvest; and,
Let your money percolate – let it ride – as long as your investment plan is working.

Compound interest or compound returns means you earn interest on your interest; or returns on your investment returns.

With each passing day, you earn more interest.

Although, depending on what you invest in, the value of your investments may rise and fall over time.

But the idea is that despite the ups and downs, if the plan works as intended, You end up with more money than you started with – way more money!

Let’s say you invest $100 today; and,
Earn interest income every month.
To keep the math simple, at an interest rate of twelve percent (12%) per year; that’s 1% per month [12% divided by 12 months].

With compound interest, in the first month, you would earn 1% on your money or $1:

$100 investment multiplied by 1% = $1.

To capture the power of compound interest or compound returns, you would leave your investment intact to earn interest next month and the month after that and so on.

At the end of the first month, your investment balance would equal:

$100 + $1 = $101.

The balance at the end of the first month – the ending balance – becomes the balance at the beginning of the second month – the beginning balance.

With compound interest, in the second month you earn interest income on your new account balance of $101.

In the second month, you earn 1% interest on $101.

Your interest income equals $1.01.

The extra penny in interest income is the interest income you earned on the $1 in interest income from the first month.

At the end of the second month, your account balance or investment balance would equal $102.01.

And so on. . .

Now you might be thinking that one penny – 1₵ – is nothing, zippo.

But if you invest more than $100, perhaps $1,000 or $10,000, you’ll really create a mountain of money for yourself and your family.

Back to our example, at the end of the first year your ending account balance would equal $112.68.

In other words, by leaving your money intact to grow, you earn interest on interest.

In fact, an additional 68₵.

$12.68 equals $1 per month multiplied by 12 months PLUS 68₵.

Which equals the extra interest income you earn from the compounding.

= = = = = = = = = = = = = = = = = = = = =

Simple Interest – in contrast, let’s explore for a moment Simple Interest.

With simple interest in contrast to compound interest, you earn interest only on the amount of money you invested at the outset, in the beginning. Under simple interest, in the first month you would earn $1 on your $100 investment. And in the second month, you would earn $1 on your $100 investment. And the same going forward.

= = = = = = = = = = = = = = = = = = = = =

Here’s How You can Grow Small Dollars into a Mountain of Money:

Develop an investment plan – select the investment or mix of investments – portfolio allocation or asset allocation that’s right for you.
Invest and invest early. The earlier the better. Because compound interest generates more money the earlier you start. This is often referred to as the “time value of money.”
Let your money ride. Absent rebalancing your investment portfolio (which means adjusting your investment mix to get back on your investment plan and is often important), Stay the Course. Be patient.
Reinvest and reinvest some more.
Invest money every month to really multiply your money!
Pay your income taxes with other money – money from sources other than your investment income. For example, your paycheck.
Pay down debt faster and ahead of schedule. Typically and this depends on your debt agreement or loan agreement, when you make debt service payments early, you reduce your outstanding principal, which reduces the interest expense you pay.

The benefit of debt pay down or debt retirement is a bit harder to see as compared to compound interest. Because when you pay down debt, you don’t have an increasing investment account or an increasing savings account balance. With debt repayment, you can see your loan amount decline and that your monthly interest expense or quarterly interest expense declines. With Excel or a financial calculator, you can calculate when your loan will actually mature – when you’ll pay it off in full which should be before the stated loan maturity date.

You can capture the massive power of compound interest and compound returns:

Invest early. Today seems like a GREAT Day to me!
Reinvest your income.

With stocks, reinvest your dividends and capital gains distributions.

Pay your income taxes with other money.

In other words, don’t withdraw money from your investment accounts or investment portfolio to pay your income taxes.

When and where appropriate, invest through tax-deferred accounts.

Examples include 401(k) plans, 403(b) plans, IRAs (Individual Retirement Accounts) and SEPs (Simplified Employee Pension Plans).

With a 401(k) plan or a 403(b) plan, if your employer offers you an “employer match” where they contribute a percentage of your salary into your 401(k) plan account or 403(b) plan account, make sure you contribute enough money throughout the year in order to receive the entire match.

Be sure to consult your human resources department or employee benefits counselors to learn how your company’s plan works and what you have to do – for example, structure your payroll deductions – to capture the entire employer match.

Another illustration about compound interest and compound returns. . .

Suppose you invest $100 and you earn 12% per year, compounded monthly:

Suppose you invest $100 when you are 25 years old. You let the money ride (or compound) for 40 years until you are 65 years old. Your ending balance would equal $11,864.77.
Instead, suppose you invest $100 when you are 30 years old. You let the money ride (or compound) for 35 years until you are 65 years old. Your ending balance would equal $6,530.96; and,
Instead, suppose you invest $100 when you are 35 years old. You let the money ride (or compound) for 30 years until you are 65 years old. Your ending balance would equal only $3,594.96.

I’m sure you can guess that the less time you have to grow – compound – your money, you’ll have to invest a lot more money to accumulate $11,864.77.

The point is, NO Matter how old you are, you can’t change history or erase your past.

BUT You can look ahead and grab the power of compound interest and compound returns, TODAY, STARTING RIGHT NOW!

And imagine if you set up an account for your children or grandchildren! That would be terrific!

Just to be clear, this amazing wealth-building strategy works now and has worked for centuries.

But keep in mind that your actual results will vary from this example, for a bunch of reasons. Be sure to consult with your investment advisors and financial advisors.

And while you’re at it, to free up cash flow so you can invest more money, save money on your groceries – easy.

Click here.

Enough for today.

Have a great week,

Arthur V.