funky gadgets & finance

Compound interest is important

May 29 2007

The most fundamental and important piece of knowledge concerning your money and your financial future is compound interest.

How can you, or anyone, end up with $1,087,000 after 20 years? (How much do you need to retire?)

What is compound interest?

It is simply where you earn interest on your interest. If you earn 10% on $100, in the 1st year, you have $10 interest. If you re-invest that $10 and do not touch the $100 you start with you get a total of $110. If you leave it for another year you will earn 10% on $110. Which is $11. Giving you a total of $121. If you do not touch your money again and re-invest your interest you will have earn $12.10 interest. As you go on, the amount of interest grows, as does the original amount. That is compound interest.

Why is compound interest good?

Because, it makes you rich. If you have the discipline to save, and then not touch your money, by the power of compound interest you can finish with a small fortune. For example, if you can save $10,000. And then not touch your savings for 20 years. And if we assume you earn 15% per year. And you re-invest all your interest. You will finish with $133,000.

Now that is a tidy little fortune, in anyone’s language. But, not as sexy as $1 million dollars, now is it..

Why is compound interest the most important thing in money?

If you truly understand not just how compound interest works, but that if you really let that understanding sink into your bones, you will want to save some money, invest it, and not touch it.

Then, through the power of compound interest, anyone can become wealthy and financially free.

You just need to leave your money, not touch it, and let the interest earn interest. Let’s say you can save as we said $10,000 and leave it for 20 years, earning an average of 13% per annum, which is the average return from the Australian Share Market, the All Ordinaries since 1950. (In the last 4 years it has been.. 15% in 2003, 28% in 2004, 23% in 2005, 24% in 2006).

Saving on top

Now. If you are able to keep saving $10,000 per year on top of your $10,000. And not touch it. What would happen. An extra $133,000 at the end? You will end up with $1,087,000. Over $1 Million dollars. Check for yourself here. (I assumed the interest is paid monthly, like most good mutual funds)

Spread the word Delicious, Digg, Reddit

Make Money On Your Blog: Text Link Ads, Pay Per Post