Albert Einstein called compound interest the eighth wonder of the world, because the concept seems a bit more magical than financial. But of course, it’s not really magic! Compound interest is a fundamental principle of the financial world that people who are Financially Fit use to grow their money.
Compound interest makes your money work for you
So how does compound interest work? It’s simple. The interest you earn each year is added to your principal, so the balance doesn’t merely grow, it grows at an increasing rate.
If you invest a dollar at 10% interest, after one year, you’ll have earned 10 cents. That’s not much, but leave it another year, and suddenly you’ll have $1.21. How? Because of compound interest.
If you reinvest that 10 cents the second year, you’ll be earning interest on the entire $1.10 — not just your original $1.00. The power of compound interest is in its simplicity. And it’s how the truly wealthy let their money work for them, rather than working for their money.
The importance of savings
Saving is the key to wealth. It’s that simple. Start saving as early as possible and save as much as you can wisely. And in order to best take advantage of the power of compound interest, you need to start investing that savings as soon as possible.
You may only be able to save a little at first, but start now. Because your investment grows exponentially, waiting even one year can make a huge difference in the amount you need to save annually in order to reach your goals.
The three rules
Compound interest takes advantage of the third of my three rules for becoming Financially Secure. They are:
#1 – Pay Yourself First – Paying yourself first and thinking about your future will get you a lot farther along the road to Financial Independence than a large salary;
#2 – Live Within Your Means – Don’t spend more than you earn; and
#3 – Reinvest your investment earnings – This is where you let your money work for you!
Talk to your financial adviser about the level of risk you feel comfortable with. It doesn’t matter if you can only invest a little for right now. As long as you are investing and reinvesting in your future, you’ll be on the path to Financial Freedom!
image credit: Bigstock/Sergey Nivens
Dr. Tony is the co-founder of MindShift.money and the best-selling author of three books on personal and business finances. Having achieved Financial Freedom at 27, Dr. Tony believes that through Financially Fit Bootcamp and Cash Flow Cure everyone can get there. He has made it his life’s mission to help others live a life where their money works for them—not the other way around.