The 8th Wonder of the World...

When one thinks of the natural wonders of the world, we usually come up with the Great Wall of China, The Pyramids in Egypt, or the one closest to home, the Grand Canyon. However, we never hear about the one that has a direct impact on your life.

OK, it may not be considered an “official” wonder of the world, but it is so powerful that Albert Einstein called it the “8th Wonder of the World.” Of course, I am talking about compound interest.

You may be asking yourself what makes compound interest so wonderful. The answer is the exponential power it has to grow your savings over time. Compound interest is simply “interest earning interest.” You’ve probably heard things like JD Rockefeller would be worth $700 billion today, or the average person could be a millionaire by the time they retire at 65.

But how?

Let’s look at an example. Assume we have $100 at an interest rate of 10%. At the end of year, we earn $10 interest income. At the end of year 2, we earn another $10. With compound interest, we also earn $10 in year 1. However, with compound interest (assuming reinvestment) we earn $11 in year 2. How? Our beginning balance is $110 (100 principal + 10 interest). $110 * .10 = $11. This may not seem like much, but when you start adding zeros, it’s a lot.

When you consider a retirement account like an IRA or 401K, not only are you considering time, but also the earnings are tax-free. The average person doesn’t comprehend this power because they’re saving small amounts at a time. If you still have doubts or aren’t great at math, check out these financial calculators pine-grove, investor.gov, or calculator site. Simply input current savings, amount saved each year, the rate of return, and time-period. Play around with each variable to see the impact. You’ll be astounded. Just like Einstein.

Keep in mind compound interest can work against you as well. If you carry large amounts of debt (mortgage, credit cards), those big numbers belong to the person you’re paying. If you have a mortgage, you’ll notice your principal hasn’t changed much in the first five years.

The lesson here is you can accumulate large sums of money, even on an average salary, as long as you re-invest the earnings. You too, can retire a millionaire by saving early, and often. The combination of compounding interest and time is the most powerful too you have in becoming financially independent.

So, do you agree with good ole Albert?