Einstein is reported to have said that compound interest is: “the eighth wonder of the world.”
So it must be pretty smart to put the benefits of compound interest to good use.
But why is it so hard to do this? Answer: Patience grasshopper, patience.
Compound interest feels is a bit like the Warren Buffet quote that one shouldn’t “save up sex for old age.”
In other words, we want to enjoy the fruits of our labor while we are young – in our present self.
That said, the 3 – 5% of the population which really gets out in front of the curve of compound interest early and make it a unbreakable money habit can quite literally ‘have their cake and eat it too.’
Almost every book on personal finance that’s out there will indicate that we should put away 10% of our income.
In essence, we are told to “tithe” to our future selves – i.e. put 1/10th of our earnings away.
Now are we supposed to roll quarters and stick them in between the wall boards and crawl spaces where we live. Of course not!
We want to invest these savings so that the beauty of compounding can occur which of course is when we start to earn “interest on interest.”
At the beginning of this sort of endeavor the returns are minimal and so most people start to feel what’s the point.
The point of course is that the longer we continue this practice, the greater the upward slope becomes.
Basically, we normally can observe linear improvements at a given ratio, but geometric ratios? Now, that’s something completely different.
I believe it was Bill Gates who said: ‘We overestimate that which we can accomplish in a year, but vastly underestimate that which we can accomplish in ten.’
And that seems to be the biggest point. Compound interest requires time. So start early!
Here’s an example of why this is so important!
Let’s say Angel starts investing $100/month at age 20 and generates a 1% return each month for 40 years and stops at 60. Angel’s out of pocket investments over those 40 years is $48,000.
Now let’s say Dick starts investing $1000/month at age 50 and also generates a 1% return each month for the 10 years he invests until he’s 60 too. Dick’s out of pocket investments are $120,000.
But get this! According to Investopedia, at 60, Angel would have $1.17 million whereas Dick would have only $230,000…!
And think about it this way. Do you think a kid just coming out of college who has been eating top ramen for the last 3 or 4 years when she gets her first job can stuff away a $100 a month out of their paycheck?
One Benji a month. That’s not too hard to ask, right?
Of course not. But, most folks don’t do that. I know because I’m a Dick!
And what that means of course is that at age 52, I am starting over and having to pay an enormous price to play catch up.
If that’s your situation too! Well, forgive your past and get started.
It’s just like the old Chinese saying that ‘the best time to plant a tree was 20 (or here actually 30) years ago, and the second best time is today!
And of course the greatest thing about making mistakes is that it gives you experience.
Now, in this case. I am not going to be able to make a quick course correction for this mistake other than to get my income up and to save quite a bit more.
But, my children and perhaps the grandchildren that my wife and I would like to one day have can be benefactors of this mistake.
Will they learn it in time? I wish I could say, you bet! That’s something you can take to the bank.
But it really comes down to their financial habits and unless they are going to purposely try to do better than us, there is a high likelihood that they will fall into the same trap.
What then? Well, just like me their going to really have to learn how to make the highest return on investment to increase their income.
In other words, they are going to have to invest in themselves! And that is where compounding really takes off…!