by Damon Carr, For New Pittsburgh Courier
Damon, I came across this meme and I wanted to get your thoughts. It reads as follows:
If you invest $40 per week into an Exchange Traded Fund that mirrors the S&P 500 which has an average yearly return of 10 percent:
- 1 year later you’ll have $2,193.00
- 5 years later you’ll have $13,287.00
- 10 years later you’ll have $34,626.00
- 30 years later you’ll have $357,097.00
- 50 years later you’ll have $2,526,696.00
Albert Einstein once said Compounding Interest is the 8th Wonder of the world. He who understands it, earns it. He who doesn’t, pays it.
~ CJ McCoy
Damon says: What is compound interest? A quick Google search defines compound interest as the addition of interest to the principal sum of a loan or deposit, or in other words, interest on interest. It is the result of reinvesting interest, rather than paying it out, so that interest in the next period is then earned on the principal sum plus previously accumulated.
In layman’s terms, it’s the accumulation of interest, earning interest, earning interest, earning interest, etc. It keeps going and going, thus growing and growing like the Energizer Bunny.
Albert Einstein, who coined the phrase compounding interest was the 8th wonder of the world, is a renowned genius. Even he was confounded by the exponential growth potential of money once it started compounding.
Here’s a mathematical illustration of compound interest. Let’s say you invest $1,000 and earn a 10 percent return over the course of a year. In one year, it’s now worth $1,100. Now the $1,100 will begin to earn interest. In effect, the $100 interest is now earning interest. This compounding effect will continue up until you withdraw the money.
If you were given the option to take $1 million right now or take one penny and allow it to double (compound) daily for 30 days, which option will you take? I share this question with my Facebook audience yearly. Most people take $1 million right now. When I first heard this scenario, I too opted for the $1 million right now. Boy was I wrong!
If you had one penny that doubled in value and compounded daily, that one brown dusty, crusty penny would compound and amass to be worth over $5 million in 30 days. That’s $5,368,709.12 to be exact. That’s the power of compounding interest. That’s the reason why compounding interest confounds experts, scholars and geniuses like Albert Einstein. Crazy, right!? I know you don’t believe me. I didn’t believe it when I read it. I created a spreadsheet to double check the math. Don’t take my word for it! I invite you to Google it.
My goal as a money coach and financial writer is simple: Teach everyday, hard working people with dreams, goals and ambition how to win with money. When I say everyday people, I’m excluding actors, sports figures, musicians, entertainers and executives who earn upwards of $500,000 per year. Although they, too, can benefit from the content I share if they want to turn their high earnings into wealth and keep it growing for generations to come like the Rockefellers.
In truth, making compounding interest a friend instead of a foe is the end game of sound financial planning—or at least, it should be. But before one can really benefit from the power of compounding interest, you must first lay a solid financial foundation so that you DON’T access, use up, or exhaust the money you have compounding prematurely. To lay a solid financial foundation, one must first earn a decent income, get their spending under control, live below their means, establish an emergency fund, and keep debt levels low to non-existent.
Easier said than done, I know! So, I write about topics and coach clients on things like “How to create a budget” and “How to create wiggle room within your budget” so that you can grow and leverage the wiggle room in your budget to establish an emergency fund, pay off debt, save and/or invest for housing, cars, vacation, college, retirement, and wealth. Saving and investing money is the cornerstone to financial stability and wealth-building! Compounding Interest is the staircase to wealth. Problem is, we as a people do a terrible job at saving, investing and taking advantage of compounding interest. We instead continue to PAY compounding interest on credit cards, furniture loans, personal loans, student loans, car loans, and mortgages to name a few.
I’m reminded of a story I share often. It’s a true story about a man named Earl. Earl resides in the Marylad area. Earl is still living and sharing his story at the time of this writing. He’s an elder Black man who worked as a parking attendant. During Earl’s working career, he never earned more than $12 per hour. He never earned more than $20,000 per year. Earl is married with 3 children. He worked, sacrificed, and put all of his children through private school. Earl, being dyslexic, wanted his children to get a quality education. Putting 3 children through private school is an amazing feat in and of itself. But that’s not the most amazing part of his story. Today, Earl and his wife are empty nesters. They are completely debt-free – including their home. What’s most impressive is that Earl has an investment portfolio valued at over $500,000. How was he able to amass $500,000 never earning more than $20,000 per year? Suffice to say Earl started investing early and benefited from the power of compounding interest. If Earl can do it, we all can do it!
Rapper and Billionaire Jay-Z said he made more millionaires than the lotto. I don’t know the truth of Jay Z’s claim. However, I can tell you with confidence that the stock market, by way of compounding interest, has definitely made more millionaires than the lotto. If only more of our people would save and invest their hard-earned dollars instead of playing the lottery.
(Damon Carr, Money Coach can be reached at 412-216-1013 or visit his website at www.damonmoneycoach.com)