Get rich slowly using compound interest

This post was inspired by a similar one from The Frugal Gene. Check out her blog for more excellent content!

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

People say this guy knew what he was talking about and I tend to agree! In this post I’ll break down the ins and outs of compound interest - how it can help you, hurt you, and why it’s the most important tool on your path to wealth.

What is compound interest?

There are two types of interest: simple & compound. Simple interest is just a fixed percentage of principal every year. Compound interest is “interest on interest” - it’s the interest received (or paid) on top of the returns from the prior interest. At this point, some of you might be saying are you talking about Matt? Let me break it down with an example.

Let’s say you save $10,000 at a 5% interest rate. After the first year, you earn $500, and your new total balance is $10,500.

In your second year, the 5% interest rate is calculated on your new balance of $10,500 - NOT the original balance. So, your interest earned in the 2nd year is $525, and your new total is $11,025. Can you see where this is going now?

Now, $1289 over 10 years may not seem like a huge amount, but if you keep depositing into the account and save for even longer, there will be huge gains 💵💵💵

The formula

Before you run away 'cause we're talking maths, I assure you the formula is simple:

Principle * (1 + Rate) ^ Time = Amount

Principle: Starting amount
Rate: Returns from investments
Time: Number of years
Amount: The stacks you will receive 💰

The Rule of 72

This is a quick shortcut that tells you how long it will take for your money to double. If your interest rate is 10%, it will take you 72/10=7.2 years to double your money.

The dark side of compound interest

Now let’s look back to the 2nd part of Einstein’s quote - “he [or she] who doesn’t…pays it”. The big banks and credit card companies also recognize the power of compound interest - and that’s how they’re so successful. Let’s use the same example above but imagine the $10,000 is debt on a credit card. After 1 year, interest on the balance becomes $10,500, and then the bank gets to charge interest on the newer balance. To make matters worse, the average credit card interest rate is 19.24%! This is why credit card debt is the worst form of debt and can snowball out of control!

How to apply this wizardry in your life 🧙🏼‍♀️

The average salary for people ages 25-34 is $41,951 per year (source), so I am using $40,000 annual salary in this example. Assuming you can save 10% of your paycheck and get a 5% interest rate here’s how your money would grow over 30 years. While you are still keeping 90% of your earnings, putting away a cumulative $120,000 the end result of almost $280,000. Pretty cool right? And...it doesn't even take enrolling at Hogwarts!

(Source: Bankrate compound savings calculator)

Personal Finance blog by Matt Gabor
Consumable knowledge bytes to chomp on your path to wealth. All posts are under 500(-ish) words. Trying to help at least one millennial become more financially literate.