Compound interest is the eighth wonder of the world. He who understands it, earns it… he who doesn’t… pays it – Albert Einstein –
When it comes to investing money, the best time to start is yesterday. The sooner you start, the more time your investment portfolio has to grow. It’s not so much how much that you have to invest that matters as much as when you begin. Smaller amounts over a longer period of time will grow more than larger amounts later due to the power of compound interest.
If you’re familiar with how compound interest works then great, you understand the value of time and reinvestment. If not, no worries, you’re about to be enlightened to another key principle of how to manage your money like the rich.
So without getting into technical jargon that can get confusing with calculations and formulas, let me put it into simple terms. Compound interest occurs from interest that is earned on an initial investment and then reinvested to earn interest on the interest previously earned. The money that your initial investment created is now working for you to earn more money. In other words, free money earning free money over and over again growing exponentially.
Once you grasp this concept, you’ll never see money the same way again and understand why money is a tool used to build wealth. This is where time is your friend. The interest starts out small but grows large over time just like the snowball rolling down a hill. This is why the sooner you start the journey to building wealth, the better. I don’t know about you, but I love the concept of free money earning free money.
Let’s put this into perspective with a hypothetical investment scenario. We’ll invest our principle and interest 10 times over and keep the numbers simple so it’s easy to follow:
$1,000.00 that pays 5% on the interest earned. Initial investment .05 x 1000 = 50.
- 1000 x .05 = 50 + 1000 = 1050
- 1050 x .05 = 52.5 + 1050 = 1102.5
- 1102.50 x .05 = 55.12 + 1102.50 = 1157.62
- 1157.62 x .05 = 57.88 + 1157.62 = 1215.50
- 1215.50 x .05 = 60.77 + 1215.50 = 1282.27
- 1282.27 x .05 = 64.11 + 1282.27 = 1346.38
- 1346.38 x .05 = 67.31 + 1346.38 = 1413.69
- 1413.69 x .05 = 70.68 + 1413.69 = 1484.37
- 1484.37 x .05 = 74.21 + 1484.37 = 1558.58
- 1558.58 x .05 = 77.92 + 1558.58 = 1636.50
So our initial investment was $1,000.00 which earned us $50 in interest. Had we just spent the interest earned (poor minded thinking) and reinvested only the $1,000 again 10 times over we’d have earned another $50 each time totaling $500.00 and not had the $136.50 difference. This is the beauty of compound interest. Because we reinvested the initial investment plus the interest each time (rich minded thinking), we made an additional 136.50 more and still have that interest working for us rather than had we just kept the $50 each time.
Now imagine having multiple investments doing this at the same time and consistently reinvesting the gains. This is where discipline and dedication that I talked about in the journey come into play. By leaving your investments alone to grow and not withdrawing from them, your investment portfolio will grow much larger and faster in the long run.
Remember, we’re paying ourselves first when we earn income and putting that to work to earn us more in perpetuity. Starting out small is better than not starting out at all so don’t let yourself get discouraged by not earning a lot in the beginning. Remember… we’re playing the long game here. Trust me, your future self will thank you for your delayed gratification now.
I can’t emphasize enough about the importance of getting into the habit of devoting a portion of what you earn towards your investment portfolio and putting that income to work for you. Anyone can afford $5 a month to get started and the next post I do will be focused on that topic to prove that it can be done thanks to modern day financial technology (fintech).
As I like to say… “the journey begins with the first step”.
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I’ll see you in the next post. Until next time… be sure to comment below and let’s get some dialogue going. I’m curious to know, what tips do you have on how to build your wealth portfolio?