Last week I talked about the free lunch available to everyone when it comes to investing.

 

This week I want to talk to you about the best friend you will ever find when it comes to investing. First name: Compound. Second name: Interest.

 

Albert Einstein once described Compound Interest as ‘the most powerful force in the universe.” He went on to say, “He who understands it, earns it... he who doesn't... pays it." He also called it, “The eighth wonder of the world”.

 

Now Einstein was a reasonably clever bloke, so I think we can all agree that Compound Interest must be an amazing thing for him to speak so glowingly.

 

So, what is Compound Interest?

 

Quite simply, it’s interest on interest. If you start with $100 and earn 10% interest, this equals $10 in interest to you and your new total is $110. You now invest the new amount ($110) and earn another 10%, and you now earn $11. ($110 at 10% = $11). This keeps repeating itself and creates a snowballing effect.

 

Let’s see an example of the power of that snowballing effect…

 

George is 20 and just started working. He’s able to save $100 a month and decides to invest this, which means he is investing $1,200 per year. Let’s assume he invests in a high-growth investment and earns 10% per annum. (Side note: people sometimes look at me like I’m from another planet if I suggest 10% per annum… let’s have a chat over the phone if you’d like me to explain how that sort of return is possible over the long-term.)

 

If George does this every year until he is 60, his money will have grown to just over $580,000!

 

Now, it’s not hard to imagine that as George gets older, he’s going to earn more and be able to save more and invest more. If he gradually increases the amount he invests each month, say every time he gets a pay rise, then the power of compounding means we’re then talking millions of dollars!

 

Let’s contrast that with George’s friend, James, who is in the same position as George, but decides to wait until he is 30 to start investing $100 a month.

 

When James hits 60, his money will have grown to around $217,000. The difference is a whopping $363,000, yet James only invested $12,000 less than George over that time ($1,200 x 10 years). Are you starting to see what Einstein was talking about?

 

This is why you want to be very, very good friends with Compound Interest!

You don't need a large amount to start gaining the benefits of Compound Interest. You just need to get started; Compound Interest can work on any amount.

 

When will you get started?

 

It’s important to point out that Compound Interest can also be your worst enemy. When it comes to debt, Compound Interest works against you. The banks know this and are therefore happy for you to take as long as possible to pay off your debts.

 

If you’d like to get to know Compound Interest a little better, I’d be happy to give you an introduction.

 

Cheers,

 

Daniel

If you’d like to find out more about how INDEPENDENT financial advice could help you manage cash flow, pay off the mortgage faster, get the most out of super and invest wisely, then get in touch on 0411 484 464 or head to wealthtrain.com.au.

Daniel McGregor is the man behind Wealth Train and is a member of the Independent Financial Advisers Association of Australia. This advice may not be suitable to you because it contains general advice which does not take into consideration any of your personal circumstances. All strategies and information provided are general advice only.