Hi there,
Most of us have heard the phrase, "time is money". Well, this is especially true when it comes to the power of compound interest. Compound interest is one of the most fascinating concepts in personal finance, and it can make a huge difference in your financial future. In today’s newsletter, we'll explore the power of compound interest and how you can use it to your advantage.
Compound interest is simply interest on interest. When you invest money, you earn interest on the initial amount you invested, but you also earn interest on the interest you earned. This means that your money grows at an exponential rate over time.
Let's say you invest $1,000 in an account that earns 5% interest per year. After one year, you'll have earned $50 in interest, bringing your total to $1,050. But in the second year, you'll earn 5% interest on the new total, which is $1,102.50. After two years, you'll have earned a total of $102.50 in interest, and your account balance will be $1,102.50. Over time, this compounding effect can make a huge difference in the growth of your investments.
As previously mentioned, this concept is most evident over long periods of time. In his book, “The Psychology of Money”, author Morgan Housel shares an example of the power of compound interest. Housel uses an example of two investors, Bob and Sally. Bob starts investing $10,000 per year at age 25 and continues to do so for 10 years. Sally starts investing the same amount at age 35 and continues to do so until she is 65. At a 7% annual return, Bob ends up with over $1.4 million by the time he is 65, while Sally only ends up with $787,000. The difference is staggering, and it is all due to - you guessed it - the power of compound interest.
One of the key takeaways from Housel's book is that compound interest is not just about money, but also about mindset. As Housel writes, "The most important financial skill is getting the goalpost to stop moving. On a long enough timeline, saving a little bit consistently is far more important than getting a great return."
Of course with every pro, there is a con. Compound interest can also work against you if you have debt. When you borrow money, you'll have to pay interest on the initial amount you borrowed, but you'll also have to pay interest on the interest you owe. This is why credit card debt can be so difficult to pay off. If you have a high balance and only make minimum payments, you could end up paying thousands of dollars in interest over time.
It is undeniable how much growth potential an investment portfolio can experience with compounding. It can make a huge difference in your financial future if you start investing early and consistently. On the other hand, if you have a hefty credit card balance, it can work against you and make it harder to get out of the darkest depths of debt (practice that tongue-twister on your own time). So, make sure to use this concept to your advantage and watch your money grow over time. Cheers to compounding!
Once again, thank you for reading.
‘Til next time,
Chase
Connect with me on Twitter: @TheIronWealth