"Compound interest is the eighth wonder of the world.
He who understands it, earns it ... he who doesn't ... pays it."

Albert Einstein

Compound interest can be the key to wealth.  Examples of how to accumulate enough money to become a millionaire are given.

You might remember the old adage, "Would you rather be given $10,000 each day for 30 days or be given a penny that doubled in value every day for 30 days?"  $10,000/day would be $300,000 in 30 days.  And the value of the penny in 30 days would be approximately $5 million.

That paradigm illustrates the value of compound interest.  Of course, no one is going to give you or me $5 million or even $300,000.  But, we can use the enormous power of compounding interest to build our own fortune. 

When I was 17 years old, I stumbled across an article explaining compound interest.  I knew that historically the stock market returned about 8 percent annually.  I proceeded to calculate (on paper, as I did not have a calculator) the future value of $1,000.

In one year the value would be $1,080 at 8 percent.  At the end of the 2nd year the value would be $1,166.40.  Somehow I came up with the future value of about $12,000 by the time I was 50 years old.  I was impressed by the conclusion that I could work for money, invest it, and money could work for me.  That is true because "money doesn't sleep".

Why had no one thought of that before, I thought?  I had saved over $5,000 at the time and, according to my calculations, would have over $60,000 at age 50, if I invested the money in the stock market and it returned 8 percent each year.  That was a large sum of money in 1960.

I was torn between investing the money or using it to fund my college education which, at the time, cost about $4,000.  I decided to go to college.  That proved to be the right decision. 

What is Compound Interest?

Compound Interest is: Savings that earns interest and, in the future, interest will be earned on both the principal and the interest. 

The Formula for Compound Interest:

FV  =  PV  x  ( 1  +  r)ⁿ

  • FV = Future Value
  • PV = Present Value
  • r   =  interest rate
  • n  =  number of periods

In the above example, my $5,000 would have magically turned into $201,052 by the time I was 65 years old.  That is, assuming that I would not have added any money to it.  Of course, there would be tax consequences unless it was in a tax-advantaged account. 

Here is another example to contemplate.  The average household income in the United States is slightly more than $50,000.  Let's assume that they pay $8,000 in state and federal taxes.  That leaves $42,000.  If only 10 percent of the after-tax income ($4,200) is saved and invested at 8 percent return, in 10 years the value would be $64,458.

Or, they could spend the money on things that they would eventually discard.  They could buy a new car, for example, and have monthly loan payments.  They, also, could live as though their spendable cash was $37,800 rather than $42,000.  Yes, there would be adjustments to be made, but the difference is $64,458 in 10 years.

In 20 years it would be $207,531 and in 30 years, $525,103 and in 40 years, $1,229,998.  The point is, start early and you can become a millionaire.

They will need to choose between the "stuff" that their money will buy or their financial future.  As a teenager, I marveled at the many immigrants who seized the opportunities available in the United States that were not obtainable in their homeland.  They were not tempted to have all of the expensive, non-essential things that so many Americans have-to-have.

They not only delayed their gratification for "stuff" (later to be discarded)but saw these items for what they are, that is, non-essential.  As a result, many became quietly wealthy. 

They believed in the philosophy to "pay yourself first".  That is not a new concept.  For example, the government takes taxes out of everyone's paycheck before the worker receives it.  They certainly belief that they should get paid first.  I recommend putting yourself in that same situation. 

We all know what the problem is.  There are stores, commodities, etc. that are competing for our dollars in this capitalistic society.  To be financially successful, we must consider ourselves more important than "stuff" if we want to be wealthy.  We must save and "pay yourself first". 

Examples of Compound Interest!

  • Save $100/mo. ($1200/yr.) for 10 years at 8% interest = $17,383
  • Save $200/mo. ($2400/yr.) for 20 years at 8% interest = $109,828
  • Save $200/mo. ($2400/yr.) for 40 years at 8% interest = $621,735
  • Save $300/mo. ($3600/yr.) for 20 years at 8% interest = $164,743
  • Save $300/mo. ($3600/yr.) for 40 years at 8% interest = $932,603
  • Save $400/mo. ($4800/yr.) for 40 years at 8% interest = $1,243,471

Save $10,000/yr. for 40 years at 8% interest = $2,590,565

(These numbers do not take into consideration taxes and inflation.)

It should be apparent that to become a millionaire, it is necessary to save and invest early in life if you are going to rely on compound interest to make you wealthy.  Take-home pay will undoubtedly increase substantially through the years and it is likely that you will be able to save more.  

But, I can assure you, if you don't start early, it won't happen.  So often, people find it is necessary to try to cram 30 years of procrastination into a few years as retirement years are approached.

The key to financial success requires discipline.  There are people who would argue that it is impossible to put 20 percent of take-home pay into savings.  I would ask them this question: "If you were making 20 percent less would you survive?"  They know that they would.

There are many ways to get rich fast, but the "odds" are dreadful.  For example, you could marry a wealthy person or inherit a fortune.  How about winning the lottery?  The safest and best way to assure that you have a million dollars at retirement is to save and take advantage of compound interest.  I suggest reading the book "The Millionaire Next Door".  As the title suggests, millionaires are increasing and they live among us. 

Rule of 72!

This is how to compute compound interest problems in your head at lightening fast speed.

The Rule of 72 states that to find the number of years necessary to double your money at a known interest rate, divide the interest rate into 72.  For example, at 8 percent interest rate; divide 8 into 72 and discover that it would take 9 years.

Conversely, to compute the number of years to double your money divide the number of years into 72 and the answer will be the interest rate necessary to accomplish that.  For example, to double your money in 6 years, divide 6 into 72 and learn that it would require an interest rate of 12 percent.

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