What you will get from this article:
- Understand the power of compounding
- Learn the true meaning of 3 common financial terms
- Discover what can happen with $1 when compound interest is maximized
- Find out how to access the ultimate financial resource, Unshakeable by Tony Robbins
Why does it seem that when you’re in the early stages of growing your wealth, low monthly contributions barely make a dent in your financial goals? What is compound interest, and why bother with it when you could get a greater return sooner through other means? It might seem easier to make a larger, riskier decision right off the bat, but in truth, the power of compound interest is an effective way to grow your wealth.
Even though it might appear that investing $1 right now is silly, you will harness the power of compounding – suddenly that $1 is worth a whole lot more. Here’s why compounding investment puts time on your side and helps you generate more wealth in the long run.
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Unlock the power of compound interest
Compound interest is perhaps the most powerful tool in your investment arsenal. Albert Einstein once called it the most important invention in all of human history. So why do so few of us take advantage? The many financial terms related to investing probably don’t help.
First, let’s clear the air with some definitions:
- Simple interest: Interest that is only earned on the principal. For example, if you had $100 and a simple interest rate of 3%, you’d earn $3 each year. Your interest earnings would never change because the principal stays the same – so you’d earn $3 in year one, $3 in year two, etc. After 20 years you’d have $100 + ($3*20), so $160 total.
- Compound interest: This interest lets you earn interest on your interest, not just the principal. No wonder Einstein loved it. If you had $100 and an annual compound interest rate of 3%, suddenly the numbers change. At the end of year one you’ll have $103. For year two, you earn interest on all $103, meaning you’ll earn $3.09 in interest that year. For year three you’ll earn interest on $106.09, and so on. After 20 years you’d have $100 * (1+.03)20, so $180.61 total. Notice how compound interest investment gives $20 more than with simple interest over the same time period.
- APY: Annual Percentage Yield. This is a percentage rate that reflects the total amount of interest paid on the account. It’s based on the interest rate compounded daily for a 365-day period. You’ll see this rate mentioned on some types of investments, like savings accounts.
With so many potential ways to utilize your compound interest investment, why not start now? Maybe the reason you’re not saving now is you’re already squeezing the most out of every paycheck. But by setting aside a dedicated percentage every check or every month, you’ll be able to gain financial freedom – even if it’s a small amount of money. Just see what can happen to $0.10 if you doubled it 19 times:
As you can see in the video, with each round you play, the number gets remarkably bigger:
Tony’s golf analogy shows that the power of compound interest can make a huge difference in your investments, whether in savings, bonds or stocks.
What can happen to $1 with compound interest investment?
Let’s go back to that $1 from the start. What would happen if you started with $1 and contributed $1 every week to a savings account with an APY of 0.25%? In 10 years, you’ll have $527. In 20 years, you’ll have $1,067.
If you started with $1 and contributed $10 every week to a savings account with an APY of 0.25%, how much would you have in 10 years? A few hundred maybe?
You’d have $5,266.60. In 20 years, $10,665.
The power of compound interest is that the more you continue to add to your savings, the more money you have to earn interest. Basically, the more you put into your compound interest investment, the faster it grows.
Sadly, U.S. savings accounts now generally have extremely low APYs; most of them have been below 1% since the Great Recession. However, as our example shows, even a few tenths of a percentage point plus regular savings contributions can make a huge difference due to how compound interest investment works. Other investment types like index funds or stocks can have much higher rates of return, but can also carry greater risks of loss.
Save early and often: The true power of compound interest
Other compelling advice to save early comes from financial expert Burton Malkiel, who created the idea of index funds. His story of two brothers investing is another great example of a money machine in action.
Take two brothers, we’ll call them William and James. Both are 65 years old. Based on the information below, which brother has more money in his account at the age of retirement when they compare their returns? William, who invested for 20 years, or James, who invested for 25? Click below to find out.
Curious to learn more about smart investing and gaining your financial freedom? Check out how to plan your financial future and smart ways to plan for retirement. Harness the power of compounding and see just where $1 can take you.
Legal Disclosure: Tony Robbins is the Chief of Investor Psychology at Creative Planning, Inc., an SEC Registered Investment Advisor (RIA) with wealth managers serving all 50 states. Mr. Robbins receives compensation for serving in this capacity based on increased business derived by Creative Planning from his services. Accordingly, Mr. Robbins has a financial incentive to refer investors to Creative Planning.
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