In a rush? Listen to this post instead:
Odds are that you have heard of the guy pictured below. He’s fundamentally changed the way we look at the physical world. Yet, despite his amazing contribution to science, he had some pretty significant thoughts about other important areas of life as well.
Compound interest is powerful, you don’t have to be a genius to understand that
CNote makes it easier to grow your savings, so what the heck does Einstein have to do with personal finance? Well, many attribute the following quote to Albert Einstein “Compound interest is the eighth wonder of the world. He who understands it, earns it … he who doesn’t … pays it.”
We can all agree Einstein was a smart guy, so what is he getting at with this quote? While we won’t pretend to speak for Einstein, we think he was trying to explain that if you can leverage compound interest to work for you—it can change the financial trajectory of your life.
Savings & Retirement
Have you ever heard people say you should start saving for retirement as early as you can? The main reason is because the earlier you start saving, the faster, and harder, compound interest will work for you. This is because compound interest works best, and magnifies your ultimate return, when you give it as much time as possible to compound on itself.
The power of compound interest is highlighted when you take the same initial investment and rate of return, but increase the amount of time you give the investment to grow. The amount of money you ultimately end up with can drastically increase even if you start saving just five to ten years earlier.
For example, let’s say you’re saving for retirement, and have $20,000 to invest and can get a return of 5%. That initial $20,000 at 25 years returns $67,727.10, yet the 35 year return is $110,320.31. Starting ten years earlier–with no additional investment–nearly doubles your ultimate return. Now that is powerful!
Avoiding high interest credit card debt
Einstein’s quote suggests that this can be a double-edged sword. And he’s right. If you owe money at a high interest rate and are unable to pay the principal down you could end up owing orders of magnitude more in interest than the amount you initially borrowed.
For example, a $1,000 loan at 20% interest that goes unpaid for ten years means you’ll owe $6,191.74, whereas at year five you’d only owe $2,488.32. Paying high debt down early is a great way to make sure compound interest does not work against you!
This is why it is so important to be careful with high-interest debt, like credit cards. Before you know it, a small loan can turn into a crippling financial burden.
So what is the takeaway? Compound interest is a powerful tool in your financial planning arsenal. If you can make it work to your benefit, and avoid having it work against you, you can greatly increase your personal wealth.