Today I am going to talk about something that’s in everybody’s mind. Compound Interest. As I’ve heard it defined, compound interest is interest that earns interest from the interest you gained from your principal. In another words, it’s money that breeds more money and all you need to do is read articles, sign up for investing accounts, and press a few buttons to execute the trade that will make all of this possible.
The Cost of a Dollar Spent
How much do you think you are spending when you spend $1 today? The answer is, it depends on what age you are at and what age you are hoping to retire at. For example, me, as a 21-year old, a dollar spent today is expensive when I take into account the power of compound interest.
By the time I turn 65 years old, if I take into account the average returns for the stock market roughly at 7%, it would have been worth $19.63.
So if I want to buy that $200 Djokovic head tennis racquet (plus taxes) because I want to play like him, I would have to imagine myself at 65, if I would have liked to have an extra $4,000 at that time or a racquet that makes me fly and be invincible on the court. Sure, $4000 won’t mean as much as today’s $4000 but I still believe $4000 will buy me a lot of stuff by the time I turn that age.
The Power of Compounding
The power of compounding is bigger than me, this blog, or anything that I’ve heard if in finance. It gives you an extra win at the end of the compounding cycle (however long that may be, seconds, minutes, or hours if you’re day trading and weeks, months, and years if you’re looking at the long term).
That extra win can give you an extra win off the extra win you already won. And so on and so on and if added together, over the long term, suddenly you’re trying to figure out where to buy your next beach house because you can’t possibly spend it all even if you wanted to!
As I’ve illustrated above, compound interest is powerful. The reason why it’s so powerful is that getting it is simple. It is not hard to go to my broker and make me invest in the Dow Jones or the S&P 500 so that in the next 44 years, I can achieve an average 7% yearly return. I don’t need to do any due diligence by reading news articles, but just have to sign a few forms for my broker and press a few buttons.
Like Warren Buffet, I am very bullish on America and its great work ethic culture. I am confident that the average returns of the stock market will beat the rise in inflation with 100% probability.
It is with this confidence that I’ve started investing in equities since March of this year (I’ve gotten very lucky and have a 10% return so far, but fingers crossed!). Even though I’m aware the stock market could shut down at any moment, I sleep soundly knowing that the companies I’ve invested in will not be shut down.
What does this mean?
I hope I’ve gotten my point across. Compounding will make your money bring home new friends when you didn’t even ask it to then those friends will bring in more friends and it will snowball even more.
Because it is so important, it’s so important to watch what you spend today because it could mean big dollars in the future. Possible items that you can put off to invest rather than spend:
- Television. I own a TV (but never use) that’s just sitting in my apartment. But if I understand correctly, the medium priced ones can go for $150 with the highest priced ones going for $1000’s. Television not only ruins your productivity and makes advertising companies richer but sets you back in retirement age. You don’t want to sacrifice both money AND time!
- Eating Out. Getting ingredients together from the grocery store and cooking does sacrifice time but it gives you health and money. I could even argue that the extra health you get will give you extra hours to your life so the net result will be positive! I’m a big proponent on increasing one’s health.
- Higher Priced Commodity Item. What do I mean? I just witnessed my mom buy $300 worth of wallets for my Dad and two handbags for herself. She was smart because it was 50% on sale but I could have bought an exact same handbag that serves the exact same purpose on Amazon without the expensive designer logo but alas, my convincing skills needs some work. It’s not just handbags, anything that you buy, you should ask yourself whether it’s a commodity you are buying that has no key differentiator except who’s selling it or if it’s a special item that you can’t get anywhere else that deserves the premium you pay for it. Remember, as Warren Buffet has said,
Price is what you pay, value is what you get
Cutting out those extra expenses can surely add to the bottom line. It can be a positive contributor to the most simplest equation you can implement to better your financial life. Remember that money is more than happy to make new friends as long as you let it. We just need to encourage it!
Readers, what do you think of compound interest?
My goal is to enable your success in personal finance so that you can realize the American dream. The first step is starting today!
Read more about me here.