Compounding interest
Want to be a millionaire? You can do it–and we can help.
Everyone dreams of being a millionaire. With careful saving, this dream may become a
reality. You’re probably saying “Yeah right, like that’ll ever happen.” But it’s true.
If you leave your money to grow for a long time, $100 can turn into a million dollars
through what is called compounding.
Compounding interest
This section involves a little math but don’t let that scare you. Give it a chance.
Understanding this concept may help you become a millionaire one day.
Let’s say you invest a certain amount of money. At the end of each year you not only
reinvest the original sum but the interest it earns as well—so that the interest (as well
as your initial investment) continues to earn additional interest. And you do this every
year after year one. Compounding interest allows someone to earn interest on interest
instead of just earning interest on the principal investment.
Here’s an example to help you better understand the concept:
If an 18-year-old saves $100 per month with a 6% growth rate until the age of 65,
he or she will have $313,187, even though they only invested $56,400. However, if he
or she delays the decision until age twenty-five, he or she will have only $199,149,
while investing $48,000. By waiting seven years, the 25-year-old missed out on the
chance to gain $114,038, which is a large chunk of change.
Now let’s say the saver happens to earn a higher return of 9%, which is possible but
requires more risk. The 18-year-old would accumulate $888,549, while the 25-year-old
would earn $468,132.
The actual dollar difference in what the two savers actually invested would be
$8,400. Whether they earned 6% or 9%, the 18-year-old earned an additional $114,038 or
$420,417 by saving early. By saving now rather than later, you’ll give your money more
time to grow.
Compounding allows your investment to gather interest. As this interest is added to
your initial investment, you can earn interest on that amount, instead of just the
principle investment. The most important factor that affects compounding is time. The
longer your money is allowed to grow, the more money you’ll make. The sooner you start,
the less you’ll actually have to save to reach your financial goals.