Believe it or not Albert Einstein is quoted as saying “The most powerful force in the universe is compound interest”. If he said that, you know there is something very powerful about the power of compounding…
Have you ever wondered how the rich stay rich? They use many financial methods that are commonly known and others that are reserved only for the world’s wealthiest individuals and families. One powerful method that us common folk can take advantage of is making millionaires everyday – compound interest.
Before we get into the meaning and power of compound interest, we must know what interest itself is. Quite simply, interest is the cost of borrowing money. Many of us know all too well how interest can work against us, whether that’s paying monthly payments on a loan, credit card or borrowing some cash from a financially savvy friend. When interest works against you, you are borrowing money from a bank or some other financial institution. When interest is working for you, you are letting a financial institution borrow your money and they are paying for the opportunity to do that.
Now that you have an understanding of the basic concept of interest, let’s compare simple interest vs. compound interest. Simple interest enables you to earn interest off of the principal (the initial amount you let someone borrow). An example is below:
Equation: Principal x Rate x Time
Savings Account: $1000 Interest: 2.5% Savings Account Balance (After 10 years): $1,800
Compound interest enables you to earn interest off of the principal and interest. An example is below:
Equation: Principal x (1 + annual interest rate) n (number of years compounded)
Savings Account: $1000 Interest: 8% Savings Account Balance (After 10 years): $2,159
As you can see, the power of compound interest makes your money work for you. You can use this comparison across any investment vehicle you choose (checking, savings account, mutual fund, etc…). You may be wondering where you can get an 8% interest rate, well I can definitely tell you where it won’t be and that’s in any standard checking/savings account through your local bank. Normally, high interest bearing accounts can be found through mutual funds. A mutual fund is a pool of money that is comprised of a lot of everyday people’s money and its purpose is to invest in companies in the market. They are able to get higher returns because they are so diversified, normally staying on par with market returns (on average 8-10%). I recommend opening a mutual fund/money market account with Sharebuilder or Fidelity.
For those of you not fully ready to take the plunge into the world of stocks, bonds and mutual funds, I recommend you opening a Washington Mutual savings account. They are currently offering a 3.30% interest rate. If you want to become a millionaire, you’ve got to think like the rich do and let your money work for you…Mo money, Mo money, Mo money!
Posted By: Dezmon Landers
Tuesday, July 29th 2008 at 7:45PM
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