Compound interest known as the eighth wonder of the world is a super powerful force in the universe, you can use a compound interest calculator and calculate the wealth accumulated through the power of compounding. Back in the days who knew about calculating compound interest? Albert Einstein knew the power yet so did bankers.
What bankers know about compounding that the average person does not know but you should
There’s a story I found searching the internet about an ancient Athenian merchant who entrusted a large sum of money to establish a trust that was supposed to run two thousand years supposedly the Athenian merchant had pocketed all the money except for one single drop which he invested in a bond that paid a measly 3% interest compounded annually supposedly the money disappeared overtime and he certainly didn’t live long enough to have seen the results but after two thousand years that single Josh Moe would have wound up being worth more than all the assets on Earth
How compounding works and why it is so powerful for all investors
Try a compound interest calculator. You can use the one on on Investor.gov
Now calculate compound interest for this scenario
if you were to invest $10,000 today and earn 7% interest
How much would you have in a year?
You would have $10,700 by the end of the year in general you would need to know several facts in order to figure out what your money would be worth the amount of money that you will be investing initially this is called the present value or initial investment
2) Now use the same $10,000 with 7% interest and compound it for 10 years. How much do you get?
Notice the initial $10,000, doing nothing to it, just letting it sit there would almost double in 10 years.
Now let’s try something a little bit more powerful, say you increased the interest rate to 12%, over 6 years what do you get for the $10,000 ? Wow, the initial seed money almost doubles in 6 years. Compare that to the earlier calculated compound interest of $10,000 over 10 years with 7% interest. With an improved interest rate, the compound interest of 12% versus 7% gets your money doubled sooner by 4 years.
Use the compound interest calculator and calculate compound interest for $10,000 over 10 years with the same 12% interest rate.
Holy Moly! The money tripled!
This is key to you as an investor, knowing that a better interest rates makes all the difference with the compounding effect.
There is also a way to reverse calculate compound interest with the compound interest calculator. Say if you want 1 million dollars during your retirement and you only have $10,000 today to invest, your calculator will tell you how many years you would need to reach that amount.
A key learning that is pretty obvious but I have to emphaHow time correlates with the results from compounding the earlier in the year you make your contributions especially for all retirement plans the more you will have at retirement
As the number of years that you make deposits without taking withdrawals increases the amount of your savings increases significantly in fact this amount grows geometrically over the years adding a few extra years of deposits can literally double or even triple your accumulation
Why slight increases in interest rate can magnify your results
Suppose you were to deposit the same $5,000 per year in a retirement plan at the beginning of each year for either 30 or 40 years instead of the 6% we originally assumed you get a compound rate of return of 9% on your investment which is the extra 3% the results 30 years at $5,000 per year grows to $449,319
Even slight increases in your investment rate of return geometrically magnifies your return
Let’s talk about the story of Manhattan what we used to pay for Manhattan 1626 Clues was $24 if the Native Americans had invested this amount at 3% until today the amount would have accumulated to $2,662,199 however they were able to get a long-term rate of 6% which would double the assumed original rate of turn the amount would have been 1.4 trillion in 2014 and with land increasing at 15.4% per year it comes out to a 6.5% interest rate return from 1626. That would be 672,210 times what they would have gotten at 3% this example dramatically shows the following points even slight increases in your Investments rate of return geometrically magnifies your return
Compound interest can work for you it can also work against you, for example if you were to start up with a dollar and you doubled your money every year without paying taxes you would have about 1,048,576 at the end of 20 years now if you were to pay 35% of that in taxes including income tax local tax state tax over the 20 year. The balance would be about $23,000
That’s a HUGE amount this is why I keep telling you that it will be very difficult to get rich unless you can keep your taxes down to the legal minimum which is why most multi-millionaires get as much tax planning as they can
The bank’s also understand the concept of compounding very well that is why they let you take out a loan as long as possible to pay the highest interest rate possible this is also why Banks love adjustable rate mortgages I also want to know that generally longer-term loans usually gain higher interest rates and cost do too great a risk by the bank of interest rate fluctuations it does that mean you’re always better off with a 15 year loan since you will be paying a lot less than interest not necessarily because you have to evaluate how much you can make on your money if you honestly feel that you can do better than what the bank is charging you you might want to use the bank’s money for a longer time however since markets and conditions vary greatly during most people’s Lifetime and since our sanity and stressing to fall market conditions most people prefer the lower term homes I have almost no loan balance which in today’s environment now seems like a smart idea in contrast to having more money exposed to risks in the stock market it is also interesting that you can pay off a 30 year loan in 15 years by simply adding about 50% more to each monthly payment not counting what is paid each month for taxes I should know that some bankers feel that having a longer Term Loan allows for more flexibility they reasoned that if you want you can make additional payments in order to Shorter the loan. It’s also a good backup in case you want to make your normal payments and have some flexibility once you are on the 15-year loan you will have less flexibility unless you refinance your loan
Two great formulas that everyone in the world should know the smart Einstein figured this out for us
Smart compounding interest calculation formula #1-Calculating how to double your money
For doubling your money take the number 72 and divide it by the interest rate that you want or we’ll get this will give you the number of years it will take to double your savings
Smart compounding interest calculation formula #2-Calculating how to tripple your money
For tripling your money take them number one 15 + / your interest rate this will give you the number of years it will take to Triple your savings the ticket examples let’s say that a stock pays a 6% dividend on all shares if you invest $50,000 today your investment will double assuming the money is reinvested in the stock at the same rate of return in 12 years if you wanted to see how long it would take to double it would take a bit over 72 divided by 6 equals 12 years.
One thing to note when calculating returns as well as savings calculators first of all the biggest drawback is that these rules and calculators assume that you will make the same rate of return each year on your investment and on your reinvested money second interest rates and dividend rates might vary from year to year unless you get a bond or flat rate certificate of deposit the bottom line is that all these rules are very valuable and should be studied however there are drawbacks that you should always take into account
Start using a compound interest calculator and see how you can get to your goals
The Five factors you need
- Amount of money you’ll be initially investing or depositing
- Amount of annual or monthly Investments or reinvestments
- Amount of interest that you can earn over All
- Number of years you want for compounding
- Total amount that you want at the end of the projected term of years