As Albert Einstein said, „Compound interest is the eighth wonder of the world.“
According to academics it is:
The more financially literate we are, the more compound interest will work in our favor, not against us.
How does compound interest work for us?
By investing long-term in diversified financial instruments.
How does compound interest work against us?
By buying all our big stuff and not just through loans. Then returning interest to our lender, compound interest works against us. By using loans, we are taking money from our future to be able to show a certain financial status or standard of living now.
Exactly how compound interest works and why it’s a good idea to start investing as early as possible.
I will give you a simple example to illustrate.
Of course, we can’t have the same yield every year, but let’s say it’s a geometric mean yield over the period.
And the example is as follows:
Two friends, Peter and John are 21 years old. They have different interests.
John is interested in his financial education, attends courses, and reads books on the subject. He decided to invest the 3000 USD he had saved when he was 21 years old. He chooses instruments that bring him an average return of 8.7% per year. He invests that much every year for 10 years. He then stops and leaves the accumulated amount to work for it, using the same tools and the same compound interest. After 10 years, the amount that will have accumulated will be 44, 931.31 USD. Allowing it to be capitalized without investing more for another 34 years, it will have become 766, 220.17 dollars. Amazing, right? Without doing anything, Peter has provided this amount for his old age. He’s supposed to retire at 65.
Let us now consider the case of John. But he thought the finance thing was complete nonsense because his father had told him so. He went to bars, smoked, and drank. He hung out with friends. He started working for a large corporation and after a while, when he turned 35, he became interested in finance. Then he already had a family and thought responsibly. He decided to invest for the next 30 years at 3,000 dollars per year with an average return of 8.7% per year.
And what do you think the result was? 386,717.20 dollars. Yes, that’s right.
In this case, we can only make up for lost time with a lot more money. Even though John invested 3 times more than Peter, he ended up with twice less money for retirement.
Conclusion
I understand how you are feeling. I was like John too. I was introduced to the world of finance when I was 30. Since then, I always think about what would I have achieved if I had come across the information I needed 10 years earlier.
The good news is that we can pass this knowledge on to the generation after us. And so they start investing from a very young. And why not, and when they are born? I mean, we, of course, do it for them. It would be great for our children to start life with a solid amount when they turn 21. And the effort to achieve that financial goal on our part would be minimal.
