Money Rules Everyone Should Know – The Miracle of Compounding

Albert Einstein called the Miracle of Compounding the greatest mathematical discovery of our time and the most powerful force in the universe.  It has also been called the eighth wonder of the world.

And once you take a close look at how compounding works it’s easy to see why.

Fortunately, the miracle of compounding is easy to understand—unlike most of Einstein’s theories–and anyone can do it.  All you need is some spare cash to invest – even a small amount, and time.  Lots of time.

Compounding simply refers to reinvesting the returns of your investments with your original investment as it is earned.  Over time even small amounts of money can add up to large sums.  The problem with compounding – if there is one – is that it’s not glamorous or spectacular.  At least not in the early years.  If you persist however, you will be rewarded with fantastic results.  Turning $2000 into $2200 in year one isn’t going to stop dinner party conversation, but by year 7 or 8 when your investment returns more than you put in each year you’ll have more interest in your investing abilities.

And it’s all done simply by investing a little, often, and leaving the returns to grow.

Let’s look at two working age individuals – Centsable One and Centsable Too.  Neither of them are slouches financially because they know the value of saving and setting a little aside for their retirement during their working years.

Centsable Too, however, is a little more up on the mathematics of finance and knows that starting early will pay huge dividends for her in the future.  With this in mind Centsable Too saves $2000 a year from the time she is 19 until she is 26 investing a total of $16,000 at the long term stock market return rate of 10%.  At 65, Centsable Too will have $1,035,315 saved for retirement.

Meanwhile Centsable One has a little more disposable income in her earlier years, than Centsable Too who started saving early.  At 25, a year before Centsable Too stops investing, Centsable One makes her retirement savings a priority, and like Centsable Too invests $2000 per year.  Waiting 6 years before starting to invest, will cost Centsable One though.

How much is surprising.

Centsable One will need to invest $2000 a year, every year, until she is 55 to match Centsable Too’s savings.  At 65, Centsable One’s savings (assuming a 10% return) will stand at $1,038,197.

BUT Centsable One had to invest $62,000 versus Centsable Too’s $16,000 to achieve the same result (more or less).The six year delay cost Centsable One $46,000!  ($62,000 -$16000).

So, the biggest gift you can give yourself is to start saving early.  The sooner you start saving, the easier time and compounding will make it to achieve your goals.  And if it’s too late for you to board the compound interest money train early, what about your kids?

How much would you need to invest for your children to give them the gift of a $1,000,000 retirement?

Tagged as: miracle of compounding, money rules