Financially Your Best Friend Is Compound Interest
Now that the puppies have your attention. Lets talk about man's best friend financially speaking; Compound Interest.
I’m sure you have read the following quote from Albert Einstein before: “Compound Interest is the eighth wonder of the world. He who understands it, earns it. He who doesn’t pays it. Compound interest is the most powerful force in the universe.” Now, I’m pretty sure Einstein didn’t actually say this (the most likely truth is that a financial journalist probably attributed it to him as a form of 20th century click bait).
However, there is a good reason that this quote is regularly attributed to one of the greatest (or at least a contender for the most famous) mathematicians of all time. Compound interest is one of the most powerful financial tools you have available to you. Effectively it is the bazooka in your arsenal.
Before I explain why it is so powerful, I should probably explain what interest is. The Cambridge Dictionary defines interest in a monetary sense as: money paid regularly at a particular rate for the use of money lent, or for delaying the repayment of a debt.
Clear as mud.
Interest affects savers and borrowers differently. For savers; interest is the money you get paid for having your money in the bank. For borrowers; interest is the extra money you pay in return on the money lent to you. The best way to explain how the compounding works is with an example.
Let’s say Sarah opens an investment account with $2,000 and each year she contributes an extra $2,000 on the first of January. Sarah has invested in a Balanced fund that returns 6% p.a.
After 26 years, she has contributed a total of $52,000. Yet due to the power of compounding she has an account balance of $125,411.53 with her compounded interest totalling $73,411.53. This is more than she has contributed the fund!
I started this article with a famous misquote, so the only appropriate way to end it is with another quote. This time I’m going to quote myself and say “Financially Your Best Friend Is Compound Interest”