Today, we’re looking at a super-important key you can use to build wealth if you can start using that key early enough… like today… like right now.
Right now, we’re in the third section of Page 17, under the title ‘A Mathematical Explosion’, in Chapter 1 of Dave Ramsey’s Complete Guide to Money.
And here’s my lesson for the day:
You need to drop everything right now… and start saving and investing every year because of the incredible power of compound interest.
Yes, that’s right.
Compound interest will favor you the best, if you can start using its power to build your wealth, if only you start today… like right now.
In fact, Albert Einstein once said, “the most powerful force in the world is compound interest.”
So, how exactly does compound interest work?
Let’s say you start with $1, and then that $1 doubles every month.
That means, your $1 turns into $2 the next month; the month after, your $2 turns into $4…
… the month after that, your $4 turns into $8; the month after that, your $8 turns into $16, and on and on.
Your money will start growing and gradually… then suddenly continue to pick up faster growth; not only because your original $1 is growing (gaining more interest), but because those doubles are growing as well (gaining more interest)…
… so that the growth has now compounded, hence the term “compound interest.”
Dave uses a more specific example in the book.
Let’s say you start with a $1,000 starting investment with an interest rate of 10% a year.
That means, for Year 1, you’ll gain 10% of $1,000, which is $100. So that at the end of that first year, your starting $1,000 would have grown into $1,100.
And with the power of compound interest, for Year 2, you’ll be starting with $1,100, not with your initial $1,000. So that at the end of that second year, your $1,100 would have grown into $1,210.
For Year 3, because of compound interest, you’ll be starting with $1,210. So that at the end of Year 3, your $1,210 would have grown into $1,331.
And that way, you’ll keep getting more interest payments not on your initial $1,000, but on your investment’s present value.
So that, every year, your investment is worth more, which means you’ll earn more… which means your investment is then worth even more, which means you’ll then earn even more… and on and on like that.
Things take speed very fast, so that the power of compound interest is not just adding interest payments to your account, but is now multiplying those payments.
Wild how that works, right?
The best case scenario for compound interest, to really go wild for you, is for you to start early. Yes, you’ll need to give it that breathing space so it can really grow and multiply.
And so, yes, for compound interest, the early bird really does catch the worm.
Dave drives home that point of starting early and starting right now on Page 18 of the Complete Guide to Money book, using an example of two persons:
If Ben, aged 19, invests $2,000 per year at a 12% annual compound interest for eight years until he’s 26 years old. And for the next thirty-nine years, until he’s sixty-five, Ben invests not one penny more…
… whereas Arthur, aged 27, invests $2,000 per year also at a 12% annual compound interest for thirty-eight years until he’s sixty-five years old…
… because of compound interest, Ben’s eight-year head start will make him $756,830 more than Arthur, because Ben started early.
All in, Ben would have earned $2,288,996, whereas Arthur would have made $1,532,166 (which still counts for something, by the way).
You can join me on Page 19 in the Complete Guide to Money book to see how the investments for both Ben and Arthur break down year-by-year.
So yes, the best way is to start early. But the biggest mistake you can make is not starting at all.
And so it doesn’t matter how old or how young you are, the most important thing you can do right now: is to start today.
Just like that popular Chinese proverb goes: The best time to plant a tree was 20 years ago. The second best time is now.
- Don’t consider yourself too young, and wrongly think you can wait or that you still have time before you start… start today.
- On the other hand, don’t consider yourself too old, and wrongly think it’s over for you… start today.
Because I promise you: 10 years from today, you’ll look back, and you’d wish you had started today.
Yes, compound interest is that powerful. And to take full advantage of the power of compound interest…
… you need to drop everything right now… and start saving and investing every year because of the incredible power of compound interest.
If you’re not sure of exactly where to invest, just start today by saving that money, so you can have piles and piles of cash ready to be invested, once we get into the chapters on investing in this book.
That’s all for today, my friend. We’ll continue in the second section of Page 20 of the book tomorrow.
See you then.