Ignoring Compounding can make you poor.
Compound interest is the eighth wonder of the world. He who understands it, earns it, he who doesn’t pays it.
Those who have earned basic numeral literacy learn Compounding in our school days. But do we really understand the term to the core?
If you really understand the term: compounding, I’m sure you will think thousand times before buying that expensive mobile phone next time.
Wikipedia definition of compound interest says:
Compound interest is the addition of interest to the principal sum of a loan or deposit, or in other words, interest on interest. It is the result of reinvesting interest, rather than paying it out, so that interest in the next period is then earned on the principal sum plus previously-accumulated interest.
The most important thing that we should appreciate about compounding is the enormous value of time. As our returns themselves start earning, and then the returns on those returns themselves start earning, the profit starts piling up at an enormous pace.
The graph below illustrates the example above and shows this clearly. The amount starts growing slowly, but as compounding takes over, the extra time means a lot more income.
The graph below shows 1 Lakh invested over a period of 10 years with compounded interest of 15%.
The most striking effect of compounding is it’s effect over longer time. To understand this consider this next graph.
Translated into a human lifetime, it means that starting to save 10 years earlier can mean earning enormously more wealth. The graph shows this clearly. If one has time to learn just one thing about investing, then it should be Compounding.
To know how rich people use compounding to their benefit? Take this example in consideration.
Bill Gates stopped working at Microsoft 10 years ago. At the time of his retirement his net worth was approximately $50 billion. Today, after 10 years his net worth is around whopping $87 billion. Yes that is enormous amount for any individual on this planet. He is making money faster than he can spend without working at Microsoft. How? Reread this post once again to know. Story does not stops here. Oxfam, the U.K. world hunger organization, meant to shame the world’s richest with its list of multi-billionaires estimates that Bill Gates’ wealth may exceed over $1 trillion at the end of 25 years. How? Reread this article again.