It is said that Albert Einstein once commented that “Compound interest is the eighth wonder of the world. He who understands it, earns it … he who doesn’t … pays it.”
The Power of Compound Interest shows that you can put your money to work and watch it grow. The power of compounding works by growing your wealth exponentially. It adds the profit earned back to the principal amount and then reinvests the entire sum to accelerate the profit earning process.
When you earn interest on savings and returns on investments, that interest (or returns) then earns interest (or returns) on itself and this amount is compounded monthly. The higher the interest rates, the faster and the more your money grows!
The sooner you start to save, the greater the benefit of compound interest. This is one reason for the success of many investors. Anyone can take advantage of the benefits of compounding through starting a disciplined savings and investing program.
Yet, compounding interest can be good or bad depending on whether you are a saver or a borrower, respectively.
Three factors will influence the rate at which your money compounds. These factors are:
- The interest rate or rate of return that you make on your investment.
- Time left to grow or the age you start investing. The more time you give your money to build upon itself, the more it compounds.
- The tax rate and when you pay taxes on your interest. You will end up with more accumulated wealth if you don’t have to pay taxes, or defer paying taxes until the end of the compounding period rather than at the end of each tax year. This is why tax-deferred accounts are so important.
Finally, it’s important to resist the temptation of seeking higher interest rates or returns, because higher interest rates and returns always bring higher risk. Unless you know what you’re doing, no matter how successful you are along the way, you always want to avoid the possibility of losing money.
Benjamin Graham, known as the father of value investing, was aware of the risk of ‘chasing yield or return’ when he said that “more money has been lost reaching for a little extra return or yield than has been lost to speculating.”
References:
- https://www.primerica.com/public/power-compound-interest.html
- https://www.thebalance.com/the-power-of-compound-interest-358054