COMPOUND INTEREST EXPLAINED: THE MAGIC OF TIME.

Fortunately, from a young age I encounter myself with the term of Compound Interest, and I immediately get fascinated about how it works and what it can achieve.

“Compound interest is the eighth wonder of the world. He who understands it, earns it … he who doesn’t … pays it” — Albert Einstein (supposedly).

Financially, the first step to start using Compound Interest in your favor is to have the capital to invest. Without capital, you can’t make investments that will later grow. That’s why the first step for you to apply Compound Interest in your financial life is to work in something that gives you a certain amount of money that you can destine to investments (if you haven’t yet), it doesn’t necessarily has to be a large sum of money.

Compound Interest explained

Compound interest can be defined as interest calculated on the initial capital plus the accumulated interests of previous periods. Think it this way: instead of removing the initial interest from the account (as with simple interest), it’s left into it. In simple terms, compound interest is interest on top of your interest. The idea that I get fascinated about was that, over various periods of time, Compound Interest will make the initial capital grow at an exponential rate.

Here’s an example:

Let’s say you have 1000USD and you invest that money on an account at “The Compounding Bank (TCB)” that pays an interest of 10% annually, with Permanency Pact for 20 years.

At the end of your first year of having your money at TCB, you’ll have 1100USD. When investing in Compound Interest, aversely than with simple interest (which is interest calculated only on the capital invested), you don’t get your interest payed, it stays at your account and the total 1100USD are re-invested for another year, and so on after completing the 20 years of this example.

This is how it looks in some of the compounding periods (the growth on your money is achieved without investing a cent more of capital on your TBC account):

Year 2: 1210USD

…..

Year 11: 2853.11USD

….

Year 20: 6727.49USD … ISN’T IT AWESOME!?

The formula for finding the amount of money you will have after investing your initial capital and all the interests it generates is:

The magic ingredient that makes compound interest work best is time

I often say to those who are having problems in their life that “time is your best friend, be patient” and I strongly think that time is also your best friend regarding your Personal Finance, be patient!

What I mean with this is that the more periods you compound your interests (the longer your money can remain uninterrupted), the greater exponential growth your initial deposit will have and the wealthier you will become.

The Compound Interest strategy is undoubtedly a long-term one. And at the same time is the easiest way for making your money efficiently work for you.

With love and desiring to help you change your mentality about money,

Daniel.