How To Make Massive Wealth Using The Power Of Compounding

The Eighth Wonder of the World?

Wait, I thought there were only 7. And don’t these Wonders have something to do with reliving cultures of the ancient world?

Not according to Einstein, possibly the smartest man who ever lived.

Einstein makes a crucial point. By understanding the power of compounding you can use it to your advantage, earn, and win. But if you don’t, you will be hindered by it, pay for it, and ultimately lose money!

I hate losing, so how do you profit from the power of compounding?

Interest is the amount of money that a financial institution pays you for keeping your money with them. For most people, this would be at a bank or credit union. It is expressed as a percentage and is calculated based on the principal amount of money you have in deposits.

Compounding interest occurs when you start to receive interest payments. The interest gets added to your principal balance. And the following period, your new principal balance earns interest. The result is interest on interest! And this phenomenon continues to happen every month while your account grows even larger!

Take a look at this example of compound interest at work. Let’s assume there are two people, Sammy Saver and Brad Buyer, each starts with 1₵. Their wealth doubles each day for 30 days. Here’s what it looks like:

On Day 8 Brad Buyer is feeling good and decides to reward himself with a 99₵ candy bar. At the end of the day, here is where each stands.

How does this play out over the long term? Keep plugging along to see what happens.

What an astounding difference between Sammy Saver and Brad Buyer, $4,152,360.96 to be exact! Mind blown. Microphone dropped. It’s incredible how a frivolous purchase early on in your wealth building journey will have a major impact on your long term financial goals!

Ok, I will admit that this example is a little extreme. But, this is exactly what happens to money over time. It starts with your savings earning interest. Then in no time, your interest is earning interest and this process continues as long as you keep your money in the account!

The sooner you start saving, the more time the power of compounding has to work for you. I guess Einstein is smarter than he looks!

Also, Investor.gov has a FREE compound interest calculator for you to try out. Plugin the numbers based on your savings goals and experience the power of compounding. Notice the difference in the total contributions and future values. The disparity between the two gets larger each year you take advantage of this tool, too!

How do most people use the power of compounding?

Unfortunatley, there’s a downside to power of compounding, too. When you borrow money, it works even harder against you!

Credit cards and certain types of loans accumulate interest on the outstanding balance. At the end of the billing cycle, you have the choice of paying the minimum or an amount above the required payment.

Paying the minimum amount due will only reduce the balance slightly. As a result, the power of compounding begins working against you and the amount you owe continues to go up!

But, anything you pay above the minimum goes directly to the principal. This causes the balance to fall more quickly and gives the power of compounding interest less time to rake you over the coals. The result, a healthier personal financial statement and more money to put towards your goals!

Consider this example, let’s assume that we have 2 borrowers, Mary Minimum and Eric Extra. They both owe $1,000 on a loan that has an 8% interest rate. It also has a $150 minimum payment. Mary pays just the minimum and it looks like this:

While, Eric pays an extra $50 per pay period:

The difference in interest charges between the 2 borrowers is $156.68. Also notice that Mary Minimum pays her debt off with the 10th payment. While Eric Extra pays his off with the seventh. As you can see, paying a little bit extra on the principal balance each month saves you time and money. There is less time for the power of compounding to work against you!

Unfortunatley, most American’s have debt with interest rates much higher than 8% and balances significantly greater than $1,000. If you have non-mortgage debt, focus on getting it paid off. Once it’s gone, be vigilant in making sure it doesn’t come back.

The best thing you can do is pay your revolving debts in full each month. Do not carry a balance. And do not let the power of compounding interest affect your financial wellbeing and future either!

Now that you understand Einstein’s message, change your relationship with interest. You can stop the financial suffering it causes. Instead, use the power of compounding to your gain!

Isn’t Einstein a genius? I think so too!

Truth be told, the power of compounding is a core financial concept. One of the main reasons for living below your means is that it gives you more money to save and invest which allows you to take even more advantage of the power of compounding, the most powerful wealth building tool that there is!