Compounding interest - How it will make you a millionaire

Compound interest (or compounding interest) is the interest on a deposit calculated based on both the initial principal and the accumulated interest from previous periods.

 

In a way, compounding interest can help you achieve your financial goals faster as it allows your money to grow more using the time available and also the growth.

To be a millionaire is everyone’s basic retirement goal, it can be achieved easily by some or takes longer by others. But compound interest, the 8th wonder of the world will help and if you can put it to good use, you will definitely benefit from it.

The earlier you start, the earlier compounding can happen and the earlier you can reach your financial goal. Recently, i came across an article published by CNBC which was about how compound interest can make a difference if you start saving and investing your money early. The author came across this chart and it changed his life.

The chart shows two different scenarios:

• You start investing at 19 and contribute $2,000 to your account every year until you reach 27. From 27 to 65, you contribute $0.
• From 19 to 26, you don’t invest anything. You start investing at 27 and contribute $2,000 to your account every year until you turn 65.
  

In the first scenario, you’re only saving and investing for eight years; in the second, you’re saving and investing for 39 years. Still, the person who starts at age 19 would end up with more money in their portfolio in the long run.

Assuming a 10% rate of return, the first person would have $1.02 million by 65, while the second person would have $805,185, a difference of more than $200,000.

As the chart shows, the sooner you can start putting your money to work, the more you’ll benefit from compound interest and the less you’ll have to save to reach your retirement goals. 

For compound interest to work, you cannot just put your money in a savings account, you have to invest it or put it in a vehicle that grows at a substantial rate. Of course, putting your money into these can carry a certain amount of risks and you can mitigate or lessen the risk through many other ways as well like diversification and making sure you have emergency funds available.

The main thing is to start investing early if you aren’t sure of how you like to invest, read up more and decide if you will buy index ETF and DCA or lump sum investment into individual companies. Whatever it is, the earlier you start, the earlier compounding can start.

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Reference article for video content:
https://www.cnbc.com/2019/07/08/self-made-millionaire-david-bach-a-chart-changed-the-way-i-think-about-money.html

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