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Compound interest might sound like a complicated process, but it’s simple. If $100 attracts 10 percent interest in one year, then we know that it gained $10, turning $100 into $110. You would start the second year with $110, and if it increases 10 percent, it would gain $11, turning $110 into $121. You will go into the third year with $121 in your pocket, and if it increases 10 percent, it would gain $12.10, turning $121 into $133.10.
“Compound interest is the eighth wonder of the world. He who understands it, earns it … he who doesn’t … pays it.” ~ Albert Einstein
It isn’t long before a snowball effect takes place. Have a look at what $100 invested at 10 percent annually can do. $100 at 10 percent compound interest a year turns into—
$161.05 after 5 years
$259.37 after 10 years
$417.72 after 15 years
$672.74 after 20 years
$1,744.94 after 30 years
$4,525.92 after 40 years
$11,739.08 after 50 years
$78,974.69 after 70 years
$204,840.02 after 80 years
$1,378,061.23 after 100 years
Some of the lengthier periods above might look dramatically unrealistic. But you don’t have to be a creepy, ageless character in the Twilight series to benefit. Someone who starts investing at 19 and who lives until they’re 90 will have money compounding in the markets for 71 years. They will spend some of it along the way, but they’ll always want to keep a portion of their money compounding in case they live to 100.
Warren Buffett applied it to become a billionaire. More importantly, so can you. Buffett has long jockeyed with Microsoft Chairman Bill Gates for the title of “World’s Richest Man.” He lives like a typical millionaire (he doesn’t spend much on material things) and he mastered the secret of investing his money early. He bought his first stock when he was 11 years old, and the multibillionaire jokes that he started too late.
Starting early is the greatest gift you can give yourself. If you start early and if you invest efficiently you can build a fortune over time. Warren Buffett famously quips: “Preparation is everything. Noah did not start building the Ark when it was raining.”
Most of us are aware of the Biblical story about Noah’s Ark. God told him to build an Ark and to collect a variety of animals, and eventually, when the rains came, they would sail off to a new beginning. Noah started building that Ark right away for himself, his family, and each type of the world’s animal. He didn’t procrastinate.
Which Investment Option is Better?
The question below showcases how powerful the “Noah Principle” of starting early really is.
- Would you rather invest $32,400 and turn it into $1,050,180? Or,
- Would you rather invest $240,000 and turn it into $813,128?
Sure it’s a foolish question. Anyone who can fog a mirror would choose A. But because most people haven’t had a strong financial education, the vast majority would be lucky to face scenario B—never mind scenario A.
If you know anyone who’s really young, they can benefit from your knowledge. They can feasibly turn $32,400 into more than a million dollars. But don’t weaken them by giving them money. Make them earn it. Here’s how it can be done.
The Bohemian Millionaire—The Best of Historical-Based Fiction
A five-year-old girl named Star is raised by her mother, Autumn, and brought up on a Bohemian island where the locals make their own clothes, and where neither men nor women use razors to shave.
Unfortunately, despite how appealing this might sound (especially at tightly congested town hall meetings) it isn’t paradise. Islanders and locals alike often throw empty aluminum beverage cans into ditches. Autumn convinces Star that collecting those cans and recycling them can help the environment and eventually make her a millionaire. Autumn takes Star to the local recycling depot where Star collects an average of $1.45 a day from refunded cans and bottles. She recognizes that if she persuades Star to earn $1.45 a day from can returns, she can invest the daily $1.45 to make Star a millionaire.
Putting it into the stock market, Star earns an average of nine percent a year. Autumn also understands what most parents do not: If she teaches Star to save, her daughter will become a financial powerhouse. But if she “gifts” Star money, rather than coaching her to earn it, then her daughter may become financially inexpert.
Fast forward 20 years. Star is now 25 years old, and although she no longer collects cans from ditches, her mother insists Star sends her a $45 monthly check (roughly $1.45 per day). Autumn continues to invest Star’s money while Star sells her handmade Dream Catchers (Image) at the local farmer’s market.
Living in New York City, Star’s best friend Lucy works as an investment banker. Living the “good life,” Lucy drives a BMW, dines at expensive restaurants, and blows the rest of her significant income on clothing, theatre shows, expensive shoes, and flashy jewelry.
At age 40, Lucy begins to save $800 a month, and she gets on Star’s case, via e-mail, about Star’s limited $45-a-month contribution to her financial future.
Star doesn’t want to talk big but she needs to set Lucy straight.
“Lucy,” she writes, “you’re the one in financial trouble, not me. It’s true that you’re investing far more money than I am, but you’ll need to invest more than $800 a month if you want as much as I’ll have when I retire.”
The e-mail puzzles Lucy, who assumes that Star must have eaten some very Bohemian mushrooms to write such puzzling nonsense.
Twenty-five years later, both women are 65 years old, and they decide to rent a retirement home together in Lake Chapala, Mexico, where their money would go a lot further.
“Well, inquires Star, “Did you invest more than $800 a month as I suggested?”
“This is coming from someone investing $45 a month?” asks Lucy with surprise.
“But Lucy, you ignored the Noah principle, so despite investing far more money, you ended up with a lot less than I did because you started investing so much later.”
Both women achieved the same return in the stock market. Some years they gained money, other years they lost money, but overall, they each averaged nine percent.
Figure 1 shows that because Star started early, she was able to invest a total of $32,400 and turn it into more than $1 million (the miracle of compound interest!). Lucy started later, invested nearly eight times more, but ended up with $237,052 less than Star.
Figure 1 Turning Less into More
So what is your plan for early investing and reaping the advantage of compound interest? It’s never late! Just go ahead and do it!
Even if it’s too late for you then guide your children to do so. But remember, do not give money to children as giving money promotes weakness and dependence. Teaching money lessons and cheerleading the struggle promotes strength, independence, and pride. (Inspired from “Millionaire Teacher” by Andrew Hallam.)
