In fact, it is nothing that really powerful about compound interest even though Albert Einstein has quoted the following:
“Compound Interest is the greatest force in the world”Einstein, are you sure about that? The compound interest itself is not powerful but it is the human mind or emotion to make it the powerful one. If I were to say, what the greatest force in the world is, I will say it is “Human Mind” – our mind. Why the compound interest can become so powerful is due to the fact that:
“We do not know how it REALLY works or we simply IGNORE it!”
How Compound Interest Works?
Compound interest simply means to REINVEST your investment return into your total investment amount. Total investment amount is called PRINCIPAL in personal finance. Let’s say I invest $100 with 10% return. The investment return is $10 and I used back this money to reinvest, so my total investment or new principal value is now becoming $110. Second year, I reinvest at $121 (new principal amount). In following years, my investment return grows exponentially…
Note: Compound interest is also applicable to loan or mortgage interest. E.g. Your loan principal amount will grow exponentially if you don’t reduce your loan principal.
The Key is Exponential Growth
Your principal grows exponentially with the compound interest, that is how the magic works and that’s why we like to say it is powerful. Looks at the chart below:
This is usually how those insurance agents use this magic to convince or trick you to buy their insurance especially for those non-term insurance policy.
In personal finance, everything is about compound interest whether you have car loan, housing loan, credit card loan, invest in stocks, unit trust, fixed deposit or the most important element in personal finance– inflation rate.
Compound interest is really that powerful by itself or we don’t understand it that makes it powerful or we ignore it that makes it powerful? What do you think?