THE 8TH WONDER OF THE WORLD: COMPOUND INTEREST

One of my favorite quotes by Albert Einstein says "Compound interest is the eighth wonder of the world. He who understands it earns it...he who doesn't...pays it".  

Compounding interest is blind to color, race and gender and it's the one element that exists in the universe that treats everyone equally. Time is your most valuable asset. You always hear people say "I wish I had more time" or "If only I could go back in time". If a person is on their deathbed and they had one wish, I imagine they would ask for more TIME. When you apply the power of Time to compounding interest, the results are truly immeasurable. Simply put, Time and Compounding interest are the most critical elements of investing.

Every dollar has the potential to become $10 some day, so why spend a dollar more than is needed? How can $1 become $10? That, ladies and gentlemen, is the snowball effect of compounding interest. With enough energy a tiny snowball eventually becomes a colossal snowball rolling downhill until it becomes an indomitable force. Wealth works in the same exact way. The money you invest today will grow at an exponential rate as it's rolling forward over time.

Compounding interest won't make you rich in a year. Ever heard the phrase, "Slow and steady wins the race"? The same can be applied to investing over time. The trick to making this work at a faster rate is reducing expenses and increase your savings rate. Steady investing over time will eventually make you a millionaire especially if you start when you're young. Critics of this notion will say it's easier to start your own business and become wealthy. And they're right. But until you land that viable business idea that will make you millions, invest as much as you can from earnings and start on the road to wealth.

DEBT NEGATES COMPOUNDING INTEREST

High rates of spending on credit starts negates the inevitable force of compounding interest. Why? The average American who makes a purchase on credit almost never pays the balance in full at the end of the month and is subjected to high interest rates. The 2016 American Household Credit Card Debt Study revealed that the average American household owes $16,061 in credit card debt with an average interest rate of 15.07%. Meanwhile the total stock market returned about 12.68% for 2016 alone. So that means the average American paid debt at a higher interest rate than the total rate of return of the US stock market. What's worse? According to Bankrate's  Money Pulse survey, only 48% of American adults have money invested in stocks. The remaining 52% have $0 invested because they simply didn't have the money to invest. The debt problem doesn't just end there. In a recent study by Experian, the average car note now stands at $503 a month while the average length of the loan is 68 months. We've gotten very good at spending and incurring large amounts of debt that restricts our ability to invest money and take advantage of time compounding interest. The big problem is our decision patterns. We continuously make wrong money decisions by spending and that creates a giant snowball that gets so big it becomes uncontrollable. Why not make the decision to spend less and invest and create a snowball that creates wealth?

HOW TO MAKE COMPOUNDING INTEREST WORK FOR YOU

The ability to effectively harness the power of compounding interest requires a change in mindset about money, making the decision to invest and exhibiting discipline. Creating a budget, reducing spending, paying off debt will inevitably increase your savings rate. The simple act of diligently saving is the single most important mechanism that makes investing work. A consistent saver who makes the decision to invest will outperform an investor who doesn't consistently save. If you're a consistent saver over time but don't invest then you're at a gross loss.  I emphasize the word DECISION because I come across a lot of people who master frugality but fall short with making their money work for them. Instead they're comforted by large amounts of cash accumulated over time in a savings account, without regard of the effects of inflation. Most people don't invest because of risk aversion. They're afraid of seeing their $10,000 investment drop to $8,000. Fear has the power to control and distort our perspectives, leading to decisions that hinder our growth. Have you ever stayed in a relationship longer than you should have? Or maybe you stayed at a job longer than needed because you were afraid to try something new? You either make fear decisions or growth decisions. Your decision to invest is a GROWTH decision because the performance of the stock market is always more positive than negative over a period of time. Investing falls in the long term planning bucket because it's not a get rich quick plan.

Then there's the one element that most people lack in many areas of their life, especially with money....DISCIPLINE. Discipline is perhaps the single most important character trait that applies to good money management and investing. Lack of discipline is the primary reason for most financial problems and also accounts for poor investment returns over time. As I referenced above, investing should NOT be part of a short term growth plan. The money you invest are funds that aren't needed in the near future. If you plan on buying a house in the next 5 years, your down payment should be parked in a money market account. If you make the decision to start creating wealth, your investment horizon should involve a 10-20 year plan. The longer you invest, the greater the returns. Discipline becomes important when you avoid responding to big market dips or even a major crash. There's a saying I learned years ago when I got into sales, "Keep your knees bent". It just simply means to be flexible or expect the unexpected. If you had invested $50,000 in 2007 in a mutual fund that tracked the stock market, when the market crashed and bottomed out 2 years later your account balance would've probably been hovering around $23,000. Those who panicked and sold, effectively locked in their losses. Those who "kept their Knees Bent"  and kept the course would today have $80,000. The benefits of applying discipline and prudence to your investment strategy is the key to success.

 

Are you taking advantage of time and compounding interest? What steps can you take today to apply this concept to your personal finances and start building wealth? Would love your feedback so drop me a line below.