Albert Einstein called compound interest "the greatest mathematical discovery of all time". We think this is true partly because, unlike the trigonometry or calculus you studied back in high school, compounding can be applied to everyday life.
The wonder of compounding (sometimes called "compound interest") transforms your working money into a state-of-the-art, highly powerful income-generating tool. Compounding is the process of generating earnings on an asset's reinvested earnings. To work, it requires two things: the re-investment of earnings and time. The more time you give your investments, the more you are able to accelerate the income potential of your original investment, which takes the pressure off of you.
To demonstrate, let's look at an example:
If you invest $100,000 today at 6%, you will have $106,000 in one year ($100,000 x 1.06). Now let's say that rather than withdraw the $600 gained from interest, you keep it in there for another year. If you continue to earn the same rate of 6%, your investment will grow to $11,2360.00 ($106,000 x 1.06) by the end of the second year.
Because you reinvested that $600, it works together with the original investment, earning you $636, which is $36 more than the previous year. This little bit extra may seem like peanuts now, but let's not forget that you didn't have to lift a finger to earn that $36. More importantly, this $36 also has the capacity to earn interest. After the next year, your investment will be worth $119,100.16 ($112,360 x 1.06). This time you earned $6741,66, which is $741,66 more interest than the first year. This increase in the amount made each year is compounding in action: interest earning interest on interest and so on. This will continue as long as you keep reinvesting and earning interest.
Starting Early
Consider two individuals, we'll name them Ram and shyam. Both Ram and shyam are the same age. When Ram was 25 she invested $15,000 at an interest rate of 5.5%. For simplicity, let's assume the interest rate was compounded annually. By the time Ram reaches 50, she will have $57,200.89 ($15,000 x [1.055^25]) in her bank account.
To demonstrate, let's look at an example:
If you invest $100,000 today at 6%, you will have $106,000 in one year ($100,000 x 1.06). Now let's say that rather than withdraw the $600 gained from interest, you keep it in there for another year. If you continue to earn the same rate of 6%, your investment will grow to $11,2360.00 ($106,000 x 1.06) by the end of the second year.
Because you reinvested that $600, it works together with the original investment, earning you $636, which is $36 more than the previous year. This little bit extra may seem like peanuts now, but let's not forget that you didn't have to lift a finger to earn that $36. More importantly, this $36 also has the capacity to earn interest. After the next year, your investment will be worth $119,100.16 ($112,360 x 1.06). This time you earned $6741,66, which is $741,66 more interest than the first year. This increase in the amount made each year is compounding in action: interest earning interest on interest and so on. This will continue as long as you keep reinvesting and earning interest.
Starting Early
Consider two individuals, we'll name them Ram and shyam. Both Ram and shyam are the same age. When Ram was 25 she invested $15,000 at an interest rate of 5.5%. For simplicity, let's assume the interest rate was compounded annually. By the time Ram reaches 50, she will have $57,200.89 ($15,000 x [1.055^25]) in her bank account.
Ram's friend, Shyam, did not start investing until he reached age 35. At that time, he invested $15,000 at the same interest rate of 5.5% compounded annually. By the time Shyam reaches age 50, he will have $33,487.15 ($15,000 x [1.055^15]) in his bank account.
What happened? Both Ram and shyam are 50 years old, but Ram has $23,713.74 ($57,200.89 - $33,487.15) more in her savings account than Shyam, even though he invested the same amount of money! By giving her investment more time to grow, Ram earned a total of $42,200.89 in interest and Shyam earned only $18,487.15.
What happened? Both Ram and shyam are 50 years old, but Ram has $23,713.74 ($57,200.89 - $33,487.15) more in her savings account than Shyam, even though he invested the same amount of money! By giving her investment more time to grow, Ram earned a total of $42,200.89 in interest and Shyam earned only $18,487.15.
No comments:
Post a Comment