The Beauty of Compounded Interest

by Minority Fortune

jigsawpuzzleThe biggest reward to re-investing your money would have to be the compound interest that it generates. It explains how the rich get richer while the poor get poorer. The wealthy store their money away and abandon it for years (maybe decades even). They prefer to watch it multiply. Whereas the poor take their money at face value and spend it. The wealthy see the future of the $100 bill. The poor only see the $100 bill.

The 72 Rule

There is a formula that you can use to determine how many years it would take for your money to double. Bill Pratt has an article taken from his book The Graduate’s Guide to Life and Money featured on Young Money Mag about the concept. You simply divide the number 72 by the specified interest rate. If the interest rate were 6%, you’d divide 72 by 6. As a result, you would get 12. That means your money would double within 12 years. Simple math, right?

We’ll quote Bill’s examples so you can get a clear picture about compounded interest:

Let’s look at a few examples. Larry, Carrie and Mary are triplets who were each given $1,000 from their parents for Christmas on their 25th birthday. Larry puts his money in the bank and earns 3 percent interest. Carrie buys some corporate bonds and earns 6 percent interest. Meanwhile, Mary invests her money in the stock market and earns a 12 percent return annually. Forty years later, when the three are ready to retire, they check to see how much money they have. Larry is disappointed when he sees that he only has $3,315. Carrie is happy to see that she has $10,957 waiting for her after selling her corporate bonds. Meanwhile, Mary is able to do all the traveling she wants in her retirement with the $118,648 she has earned from the stock market!

To get an even better picture of how compounding works, let’s say the three siblings from the above example decided to save an additional $1,000 each year until age 65. After 40 years, Larry would have about $80,000, which is not bad, considering he only had to contribute a total of $40,000. Carrie would have about $175,000, which is really good considering she also contributed the same amount, $40,000, over her working career. Mary, if you can believe it, would have over $1 million. That’s right, she would have over $1 million and she only had to save a total of $40,000 over her working career. Mary is on her way to a very comfortable retirement.

You too can be that Mary the next time you have a spare $1,000 in your hands. While compounded interest has a slow start, it picks up momentum as time passes. Be patient. Challenge yourself to invest it and then forget it. When retirement comes around, you’ll suddenly have a bundle of compounded money at your disposal. Now that’s wealth!

*Image courtesy of Michael Hitoshi.
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