The Magic of Compounding
Updated: Jan 20, 2022
Compounding is one of the key secrets of the wealthy and one that young people don't learn till later in life, when it's too late!
Albert Einstein once said “Compounding is the 8th Wonder of the World” and for a very good reason!
Compound interest is like a snowball that’s rolling downhill. As it picks up momentum, it gets bigger and bigger. Compounding can turn a small investment into a large amount, you just need the time to leave it in there and the patience to let it grow without taking money out of it. If you add regular sums as well to your investment, then it grows to even larger sums when you want it at the end.
If you want to be wealthy, one way to get there is to invest month over month for as long as you live. The key is consistency. Put simply, the sooner you invest your money and the more you add regularly to the investment the more you’ll benefit from compound interest.
SO HOW DOES COMPOUNDING WORK?
When you invest an amount of money and earn that return then reinvest that return back into the investment and it continues over and over again until it snowballs into an eye watering sum if you give it enough time.
Say you start with $1000 in year 1 and get a 10% return on it which is $100 return
Then in year 2 you will get a return of 10% on your $1,100 which equals $121 return
Then in year 3 you will get a return of 10% on your $1,221 which is $122.1 return
When you first start on compounding, your investment grows very slowly for the first few years and that's where you have to be patient and stick to the strategy no matter what. It’s in the final years where the return just jumps up exponentially! Just like a snowball running down the hill getting bigger and bigger. The longer you can leave it compounding the better!
We suggest you start to save and start investing as early as you can. An investor once said “the best time to start an investment was last year, and the next best time is now!”
But be warned that compounding can be a double edged sword and can work exactly the other way strongly against you.
When you don’t pay back bad debts like credit card balances, you are actually having interest compounds against you that can snowball hugely in time. So instead of your bank balance growing like a runaway snowball, your debts are instead!
When you are young there are many traps set by marketers, banks, finance companies and the whole consumer society in general tempting you to spend more than you can afford and get you into bad debt. The whole world is marketing to you to have the latest and greatest product and as soon as you start earning money independently, you have to make decisions all day about your money.
So be very careful about what you use compounding for. If you understand it and use it well, it can really work in your favour and be an amazing magic tool and be one of the most powerful tools to help you build wealth. If used incorrectly it can put you in a financial hole that you will find very hard to get out of…..
If you enjoyed this blog and want to learn about money skills and the wealth mindset then check out our series of great courses on this link!
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