Want to know the power of compounding returns? Einstein called compounding interest, “the greatest mathematical discovery of all time”. As far as I can tell, money is a renewable resource. A lot of money will make more money, as long as you have time.
I will present to you two scenarios that will instantly show how time, interest, and compounding interest can increase money quite rapidly.
Scenario 1: You are a 22 year old person with a plan to be rich. You know the power of compounding interest and make it a habit to save early. That is why you have made it your goal to save $100,000 by the time you are 30 years old and stop. This means that you will need to put away a little more than $12,000 every year (or save $1,000 a month) until you reach 30 in a cash account. However, you can only afford to put down $8,000 a year but are okay with taking on more risk and instead of putting it in a bank account, you wisely invest it in the stock market and hope to achieve that average return of 8%.
Scenario 2: You are the older brother of this bright 22 year old, and at age 30, you are also thinking about saving. That is why you have also decided to save $8,000 a year until you retire at age 70. Like your younger brother, you can take on more risk and will invest your money in stocks hoping to reach that 8% return each year.
|Rate of Return||8%|
Conclusion: The interesting thing about this is, once the 22 year old has accumulated $100,000 by the time he is 30, he will not have to put away any more money, and let compounding returns take hold. By the time the two brothers are 70 years old, the younger brother will still have more money than the older brother ($2,343,913 VS $2,187,561). This is despite the fact the the older brother will continue to contribute $8,000 until he retires and the younger brother doesn’t.
Lesson learned? Save EARLY, and hopefully try to achieve that $100,000 by the age of 30. Once you have done that, you will not have to save any more money and have 2.2 million in your bank account by the time you are 70.