Why is it that money becomes more money? Here we will explain it in more detail: the compound interest effect. Albert Einstein called compound interest one of the greatest forces in the universe. “Compound interest is the 8th wonder of the world. He who understands it, earns it; he who doesn’t, pays it.” It is the principle where your money earns interest and that interest in turn earns interest for you. In this article we deep dive on why investing your money can be the smartest decision you will make!
It is an effect that becomes more and more powerful as it builds itself. The two variables that determine the extent of the effect are return and time. The higher the return and the longer the time the investment can do its work, the greater the “compound effect”. This means that investing is a matter for patient people. It is said that the best investors are dead investors.
The eighth wonder of the world is what makes investing so attractive. Your money can create a snowball effect, and continue to increase in value without you having to do anything. A mathematical formula has even been created to quickly calculate the power of compound interest. Letting our money become more money, how nice?!
But how exactly does this work? Well, like this
Suppose you invest € 100 and the return in year 1 is 5%, then your € 100 after year 1 has become worth € 105. So in year 2 you start with € 105 and the return is 5% that year too. Then it will not be € 110, but € 110.25. A small difference, but that difference is going to change your life. Take a look at the numbers below if you continue this example:
Year 1: €105
Year 2: €110.25
Year 3: €115.76
Year 4: €121, 55
Year 5: €127.63
Year 6: €131, 1
Year 7: € 137.66
Year 8: €144.53
Year 9: €151.76
Year 10: €159.35
Even small amounts like €100 have become worth no less than €160 after 10 years. And every year the interest that you receive is higher. Imagine that you invest an amount every month, for example €50 or €100, which will pay off for you.
But how do you take advantage of this?
Ultimately, your profit or loss is only real after you cash it in. So when you withdraw your money, you see what your return on your investment has been all these years. But you don’t want to do that too early, the longer you invest your money, the longer this compound effect can do its job. Suppose at some point you have a ton of assets, and you make a nice return for a certain year. Then you can withdraw the winning amount and use it to live on. You can leave the rest of your already built up capital to ‘let it do its job’ and have it return again.
To truly see compound interest at its best, you need to give your investments time. Invest regularly, even if it’s with small amounts. Put the money to work, calm down your nerves when the markets go up&down and stick to the plan. And if you doubt whether it’s going to work: trust Albert, he knows 😉