Everyone wants to get rich. But few people actually leverage the easiest, most foolproof way to grow your wealth. No, it’s not investing in bitcoin or your friend’s latest startup. It’s called compound interest, and it allows you to magically grow small amounts of money into HUGE amounts over time. The key, though, is to start early. Here’s why.
What is Compound Interest?
So what is compound interest? And how does it work? Compound interest is interest earned on interest, which leads to a substantial growth of your investments over time. Even a small initial investment amount can lead to higher wealth accumulation, provided you start early and think long-term.
Basically, compound interest is what happens when you reinvest your earnings, which then earn interest as well, resulting in a snowball effect. The earlier you start, even with a smaller investment, the bigger your cash snowball will grow.
In the video embedded above, we used the example of Sarah and George. Say both Sarah and George enjoy the same return rate of 8%. But Sarah invests early, at age 22, and only invests $6,000 a year for 10 years. After that, she doesn’t invest another dime, but allows her compound interest to grow.
Meanwhile, George waits until he’s 32 to start investing. He invests the same amount every year, until his retirement, at 65.
In total, Sarah only invested $60,000 total, compared to George’s $204,000. Who do you think was the wealthiest of the two at 65 years old? Thanks to Sarah’s early start, she actually ends up with $1.3 million at retirement, where George has $1 million. Both are excellent, of course, but if George had started when Sarah did, he’d be richer at retirement.
The Rule of 72
Want to double your money? The Rule of 72 is a fun tool that can help you estimate the number of years you’d need to double your money at a given annual rate of return. All you have to do is divide 72 by your rate of return to get a rough estimate of how many years it will take for the initial investment to duplicate itself.
How the Rule of 72 Works
If we look at our example in the video, every $6,000 Sarah and George invest earns 8% per year. If we divide 72 by 8, we get 9 years. This means that every 9 years, that $6,000 will double.
Since Sarah started to invest quite a few years before the other, we can easily see how the exponential curve was hard for George to catch.
The Rule of 72 is reasonably accurate for low rates of return. Try it yourself with this handy calculator to find out for yourself how long it will take to double your investment.