Investment 101: How Compound Interest Can Make You a Millionaire

by Nicole
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Thanks for visiting my series on investments. This is part 2 of these series. If there is a topic you would like to be covered, please let me know. To read part 1, “Investment 101: How the 401K Can Increase Your Wealth”, click here.

How Can Interest Hurt You

My biggest motivation to pay off my student loans as fast as I did was watching the interest pile on. I couldn’t stand to watch the interest on my loans accrue at an annual rate of ~5%. If I had simply followed the suggested payment timeline and paid $636 per month, it would have taken me 10 years to pay off my student loans. At that rate, on top of the principle, I would have paid over $16,000 in interest. This number frightened me! My college education was valuable but I wasn’t willing to hand over an extra $16,000 just for interest fees.

Put simply, the longer it takes to pay off a debt, the more money will be taken from you (in interest). This same concept applies to credit cards, auto loans, mortgages, or any loan that accrues interest. 

 

Those that understand it, earn it; those that don't, pay it.

To be in control of my financial situation and beat the banks required serious sacrifices to be made on my part. I needed to buckle down and begin paying as much towards the principle as I physically could. I’ll be honest, this wasn’t easy and for at least a year, I lived very minimally to become debt free. The sacrifices made then, were completely worth the freedom I have now. 

My student loan example and the interest I was paying on them is an example of compound interest working against me. That being said, compound interest can also be an incredible tool to gaining wealth.

Let’s make compound interest a little more INTERESTing

Compound interest is the concept of earning interest on your investment AND earning interest on the interest! Over time this results in the exponential growth of your money. Per the chart below, you’ll notice in the first few years of investing your deposits make up a large sum of the total wealth. Patience is a virtue when it comes to investing though. If you do not touch this money and let it sit, growing at a rate of 8% per year, by the end of the investment period, perhaps 40 years later, you can see that you’re making more money on compound interest than you are from your contributions.

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You can use this website to calculate your rate of growth based on how much money you want to contribute. You’ll find this website to be very simple and understandable. 

Still a Bit Confused? This Should Help.

Here is another example from one of my favorite, easy to read financial books, “Broke Millennial”, by Erin Lowry.

On average, the market usually provides an 8% annual return. Some years it will be higher, other years it will be lower. If you invest $100 and receive an 8% return after year 1, you now have $108.  You decide not to invest anymore and leave the $108 alone.

In year 2, you’ll earn interest not only on your $100 investment but on the additional $8 (this is compound interest). If you get another 8% return that year you’ve earned $8.64 and now have $116.64 (and you didn’t even do anything)! 

This is the most powerful way to grow your wealth!

When you dabble enough in personal finance content you’ll understand investing is well suited for the young investor because the earlier you start, the more you will make. Compound interest is favorable for young people! 

You Don't Need to Be Rich To Start

You can see from the example above, that despite what some people think, you do not need to be rich to start investing. In fact, the only easy way to get rich is by investing early in life. Do not wait. Even if you only have $100 to start with, you can see from the above example that compound interest will work in your favor! 

The Power of NOW

Here’s one more example that will hopefully hit home. I wanted to use this chart to show you the power of investing now, rather than later. Look at the difference 10 years can make. If you waited 10 years to invest it would cost you $600,000. That is the power of compound interest. The facts don’t lie. 

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Don’t let the word “investment”, “compound interest”, or any other financial term deter you from starting. It is a lot simpler than you think. Watch the video below to get a deeper understanding or even read this article again. If you need further clarification, I’d be happy to help

XO,

Nicole

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1 comment

Investment 101: What is an IRA and How Does It Work - A Healthy Profit June 8, 2020 - 11:23 am

[…] To read part 2, “Investment 101: How Compound Interest Can Make You a Millionaire”, click here.  […]

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