Key #2: Compound interest.

The way to make money increase is to invest it where it will grow undisturbed. Then, reinvest the profits to compound the interest the money is earning. You will earn interest on the interest.

Compound interest refers to whenever interest is calculated, it is calculated not only on the original principal, but also on the interest that has been added to the principal. The more frequently interest is compounded, the faster the balance grows. In other words, you get paid interest on the interest in addition to interest on the principal.


The second key to financial independence is a simple one but a complicated one. It is one that is always mentioned when the talk is about saving, wealth, getting out of debt and so on - indeed, all those things that can lead to financial independence.

But do we all fully appreciate the effect of compound interest? You've seen the numbers -- save $xx per month and it will accumulate until you are rich by the time you retire. But some of the best things about compound interest get lost in practical living. Like for example---

If you save $100 per month for ten years and then stop but leave the money earning interest for the next 30 years, you will have more money in the bank than if you were to not save for the first ten years and then save $100 per month for the next 30 years.

Anyone have any other exciting stories about this dull subject?

If you save $200 per month at 3% interest that will give you $116,838 after 30 years (compounded monthly)

... but if you withdraw the interest every month, you will get 5 cents at the end of the first month rising to $180 in the last month, a total withdrawal over 30 years of $32,400 and still have the $72,000 you saved.

... However, if you don't withdraw the interest, you will earn $44,838 in interest, an extra $12,438 which was interest on the interest for a final $116,838.

“The most powerful force in the universe is compound interest” Albert Einstein

Einstein actually saying that remains dubious at best but the idea remains intact.

I don't know that I have an exciting story, but I do have a provocative question.

How can we get this information to children? Late teens, specifically.

When I was a teen, everyone said you should save, but no one, I mean no one (and I took a practical math class, like how to balance your checkbook) showed me an example of compound interest. I didn't see this until I was well into my thirties, at a Women and Money conference led by Kathleen Brown and B of A. I remember being absolutely stunned.

Most of the twenty-somethings I have ever known thing things like, well, I really want X right now, and I'll have plenty of time to save later (when I get a good job, when I'm married, when I'm stable, when I'm less broke).

So, all you motivational successful leader people, any ideas on how share the message of compound interest with those to whom it may do the most good?

Excellent question, TB. In fact, schooldays were so long ago for me I have no idea what is and isn't taught in schools these days. Maybe compound interest wasn't invented when I was at school :D

Certainly it should be taught in school, but let's not rely on other people - perhaps a child's education is really the responsibility of the parent. And whose responsibility is it to teach the parent? Surely, this comes down to self improvement. Shouldn't we all find out for ourselves what we need to live a superior life?

I think the main problem lies in the general dislike and avoidance of mathematics. Nobody seems to enjoy numbers any more. When I was young, playing number games was almost an indoor sport! We took pride in our number ability. Now, it seems, shooting electronic Klingons seems more rewarding. If we could get the kids interested in numbers again, compound interest would be a fun topic, for sure.

...So, all you motivational successful leader people, any ideas on how share the message of compound interest with those to whom it may do the most good?Has anyone any good ideas about how to get young people to understand the power of compound interest?

Do your kids know about it and understand it?

If so, how did they learn it? from where did they learn it? and what are they doing with the knowledge?

If not, what can you do to teach them this most important lesson?

If you don't have children of your own, how can you help young people around you - nephews and nieces, neighbor's kids, etc?

Here is something I heard a long time ago that falls into this subject of getting children into the habit of managing money properly and especially saving. It is a message that every parent should adopt, if they want their children to succeed in life.

Try this - Children, at a very early age, are given "pocket-money." This is a few dollars of their own to do with as they please. But, of course, at so tender an age, they don't know what to do with it and are open to advice. The advice given is--

1) Save one third of it
2) Give one third of it away
3) Spend the remaining one third.

Every "payday" - once a week - has a short "conference" in which the child or children are given their money and "helped" to "play the game." 1/3 saved - with a report of total accumulated to date, including interest earned. 1/3 to be given away - to whom will this week's donation be given and why? 1/3 to be spent - on what will it be spent and why?

This last segment - the spending portion - is allowed to be accumulated (saved) for a specific larger purchase that would take place after sufficient money had been accumulated.

Notice what the child gets into the habit of doing --

First and foremost, Save.

Secondly, be charitable and generous.

Thirdly, to enjoy money - to have fun things and to accumulate money for a large purchase. Learning the joy of instant gratification and the art of patience. Notice, that this short-term 'saving' is not confused with the long term saving in segment #1.

This 'game' is started at an age when the child barely understands what money is, so grows up learning about money in the context of life. They do not - like so many of us - reach adulthood believing that money is always scarce ("We can't afford it!"), always a cause of conflict ("Why did you waste money on that!") and something to be avoided ("Money is the root of all evil!") They are not made to feel guilty over money ("You're just greedy!") and they learn how to manage money, how to save it (leading to how to invest it) and how to be generous and charitable.

Seems to me like a wonderful series of lessons that could be accomplished in about 15 minutes, once a week.

What do you think?

If you save $100 per month for ten years and then stop but leave the money earning interest for the next 30 years, you will have more money in the bank than if you were to not save for the first ten years and then save $100 per month for the next 30 years.

Can you readjust those calculations for inflation?

Can you readjust those calculations for inflation?I don't have a methematical formula to do that, but I imagine it could be done.

I think that would make the emotional impact of the result more realistic.

I think the biggest problem with the compound interest key to wealth is that, by the time people clue in how important it is, they're getting on in years and the magic of the formula doesn't do much good. It's too late to get much benefit out of it.

What's the solution for people who start late?

Corinne, The principle of compound interest works at all ages. It is true that reinvesting the interest earned in a passbook savings account takes a long time, but the clue to success is in the speed of the compounding. If you compound daily, it is far more effective and far more profitable than compounding monthly or yearly.

So, in what vehicles can you compound more quickly?

Reinvesting the profits from a business. Reinvesting the dividends from stockholdings. Reinvesting rent earned from a rental property. These are all compounding of interest.

The solution *for* people who start late is to find a more profitable vehicle.

The solution *to* people starting late is to start them early - see my post above - http://www.successvibe.com/forum/showpost.php?p=153396&postcount=7

The compound interest calculator is perfect for just these sorts of comparisons, stories, hypotheticals, questions:
http://www.moneychimp.com/calculator/compound_interest_calculator.htm

Actually, Spider, I tried running your example through that, and it didn't hold. (I was expecting it to. i LOVE that example. I've been a big fan of that example) I ran it with 3% interest (for giggles and because i had to choose something)

Could we talk specifics about compounding?

That calculator asks how many times it compounds. It also asks if you add deposits at the start or end of each compounding period. If you add at the end, the amount is much smaller.

:hmm:

TB, you are right - it doesn't work at 3%. I checked, using the calculator you used, and found that it works at interest rates 4.85% and above.