How to Get Rich: Compound Interest Write an image caption

Do you ever wonder how most rich people actually build their wealth? Simple. They invest their money and take advantage of compound interest. Compound interest is the best short-cut to building long-term wealth. One investigative report found that of 233 “rich” individuals (net assets of at least $3.2 million), 49% of them saved and invested at least 20% of their income (1). The great thing is, a lot of them didn’t start with a ton of money to begin with. People like you and me can build wealth just as easily, and becoming rich over time with very little work.

Rich people make their money work for them, all thanks to compound interest. Making your money work for you is a lot easier than you think.

The Basics

First and foremost, to take advantage of compound interest, you need skin in the game. This means investing and holding assets in the stock market. Once you have money in the market and a basic investment strategy, compound interest can go to work.

At its core, compound interest is “interest on interest” (2). Because the stock market historically yields a positive (8–10% average) yearly return on investment, every dollar that you invested gains interest. If the stock market and its assets continue to rise in value long-term, which will happen, then your interest is now gaining interest. Interest on interest. An easy analogy is a snowball rolling down a hill. Initially, the snowball is small (your initial investment). But over time, as the snowball collects more snow rolling down the hill (interest), the snowball grows exponentially larger (interest on interest).

Let's walk through an example.

A $10,000 principal (beginning amount/investment), compounded annually at 5%, yields over $40,000 after 30 years. And this is with no additional money invested. Just a simple example of $10,000 and compound interest. This growth is purely a result of compound interest making your money work for you. Compound interest let’s things grow exponentially. Remember, interest on interest on interest and so on. Wealth building in action.

Here are some great quotes from people I hope you have heard of, talking about compound interest:

“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 is an investor’s best friend.”- Warren Buffet

That’s right, even Albert Einstein was no stranger to compound interest. Think of every dollar you invest like an individual worker whose sole job is to make you more money. Each dollar you invest makes you pennies to the dollar, for free (8–10% average annual return in the stock market). Those pennies that your dollar just made now go out and recruit even more pennies, so on and so forth. Over time, the number of workers (dollars and pennies) you have invested continues to generate you more and more dollars. Combine this with exponential growth and you have your key to building long-term wealth.

It truly is a snowball effect. The equation is simple:

consistent investing + time + compound interest = lots and lots of money

What You Should Do

I hope you now understand how beneficial compound interest can be. I said getting rich is easy, so what should your next steps be?

Invest as early and as much as you can. Compound interest is like fine wine, it gets better with time. Given that we all won’t live forever (at the time of writing this), time is our worst enemy. Remember, compound interest helps you grow your investments exponentially. Interest on interest on interest. Investing as early as you can, and as comfortably as you can, will give you the most time to see your money grow.

Be patient. Because compound interest takes time to realize the immense benefits, be a patient investor. Emotional investing (trying to time the market) will more than likely lead you to lose your money if you don’t know what you are doing. Be consistent, stick to your plan and watch your money grow over time with the power of compound interest. For 99% of investors, investing rewards the patient and punishes the impatient. Don’t wait to start building your wealth.

Sources:

1) How the Rich Got Rich (Business Insider)

2) Compound Interest (Investopedia)

3) Compound Interest Calculator (NerdWallet)