Wealth Creation: The Miracles of Compounding Interest

The following is a guest post written by Paul Damazo, author of 80 Proven Ways to Become a Millionaire, All you need is two or three! For those of you interested, here's a series I wrote a long time ago on The Richest Man in Babylon.

If you struggle to survive financially, you are not alone. Isn't it amazing that in the two most important areas of our lives-finances and relationships-most of us have not had even one hour of training. This is crazy! 

I'm sure you've heard about the Law of Attraction and you know the Law of Gravity. Did you know there are also Laws of Wealth Creation. Perhaps you were never taught them or you do not use them.   

Let me share what I learned from one of my favorite books. 

The Secrets of The Richest Man In Babylon

You can succeed financially! It is quite simple, boiling down to three simple secrets that go back to old Babylon. The book, The Richest Man in Babylon, by George S. Clason, shares Arkad's secrets to becoming wealthy and makes the financial concept of compound interest fun to read and easy to understand. 

What makes his story so interesting is that Arkad did not begin life wealthy. Poor when a young man, he wanted to experience more of life than what his childhood circumstances had to offer.   

Arkad's friends were confused as to why he had so much more money than they did. As children, they had been equal. They had played, studied, and worked together. Nothing had set Arkad apart. So, what was his secret? How come Arkad had all the "luck"? Didn't they "deserve" to be wealthy? 

To Arkad's childhood friends, it seemed very unfair that ordinary little Arkad somehow became the richest man in Babylon, while they struggled daily to survive. 

Arkad shared with his friends that when he was younger he had observed that many things were possible when one had wealth. Being happy and content was a great way to live and having wealth made it even easier. He consciously made the choice to be happy and wealthy! He set out to learn wealth creation and then focused on doing it well.   

Arkad doesn't try to defend his good fortune or to apologize for it. Instead, he sets out to share his secrets. And what he makes very clear is that these "secrets" aren't really secret at all. They are simple formulas anyone can learn. Yes, you can become wealthy.   

Secret 1: Arkad decided  "A part of all I earn is mine to keep."   

He found the road to wealth when he kept and invested for himself one-tenth of all he earned. Start with 1% and work up to 10% or more as quickly as you can. Just start!   

Secret 2: He invested wisely.   

Arkad learned to save and invest and reinvest his money. He told his friends they should put their money and that money's children (i.e., the interest or return on their money) to work for them. 

Make your money work hard for you rather than you working hard for your money. Have the patience and persistence to let your money grow, compounding each year.   

Have a large money tree. The more money you save, the more money you can put to work for yourself.    

Secret 3: He enjoyed his wealth.   

Arkad was famous for his wealth, kindness, and generosity. He gave graciously to charities, was generous with his family, and liberal with his own expenses. 

If you are serious about your wealth creation and becoming a millionaire, you will quickly differentiate between your needs versus your wants, and you will not be involved with instant gratification.   

The Amazing Secret of Compounding

Compounding can work for you or against you. When you borrow money, compounding works against you and takes more of your money, sometimes far more than the amount you initially borrowed. When you save and invest money, compounding works for you, paying you more money every day. 

You can become very wealthy. Compound interest grows gigantically faster than simple interest. The younger you are, the more you can use this "secret" to your advantage. Start now compounding interest and watch how fast your investments will grow. 

When comparing simple and compounding interest, imagine a duck and a jet, both ready to fly. The duck takes off slowly, staying close to the ground while gradually picking up height. The jet speeds down the runway, starts climbing rapidly, eventually climbing so high and so fast it appears to be going straight up. The jet is like compounding interest.   

Time is Magic 

"Compound interest is the greatest mathematical discovery of all time," said Dr. Albert Einstein. The results are determined by time, not just how much you invest!  Time really is magic.   

The Rule of 72 developed by Dr. Albert Einstein is an easy way to estimate how long it will take for your money to double with annual compounding. (Divide 72 by the percentage growth rate.) For example, with a 15% return your money doubles every 4.8 years. Round it to five years (for simplicity's sake). This means a $5,000 one-time investment made at birth by parents and grandparents would grow to $2,560,000 when the child is 45 years old. This awesome result is based on two major factors-compounding earned interest and time. 

Remember that Wealth is a Matter of Choice-Yours Alone. Choose today to become a millionaire, to focus on your wealth creation, to create a life you love for you and your loved ones. 

NOTE: This article is designed to inspire you into action and to provide accurate and authoritative information in regard to the subject matter covered. Factual material has been obtained from sources believed to be reliable, and is not guaranteed. All examples are for illustrative purposes only and are not to be construed as recommendations, advice, or tax counsel. The author is not engaged in rendering legal, accounting, or other professional service. If legal or other expert assistance is required, the author strongly recommends that the reader should contact his own professional advisors. 

Past performance should not be taken as being representative of future results. Anything tax-related should be discussed with your accountant before it is used for tax purposes. All information provided in this article is for informational purposes only.

Comments

[Master Your Card]

Great post - I didn't know about the rule of 72, I'll certainly keep that in mind!

By the way, is the legal disclaimer at the end really necessary? Not trying to be snarky, just wondering if I should be putting it at the end of all my posts :)

[Colin]

I have to think that the rule of 72 predates Einstein. According to Wikipedia, it was referenced by Luca Pacioli (the father of modern accounting) in Summa de Arithmetica in 1494, and probably predates that.

I've heard that Einstein quote before, and always wondered what his context was, though...

[FMF]

Master --

The disclaimer at the end was submitted by the guest poster when he gave me the piece, that's why I've included it.

[Michael]

Yeah, it's not Einstein's rule... it has been around for centuries..

[JimmyDaGeek]

Please correct a common error that people make. All modern-day loans use simple, not compound, interest.

Whether you pay a credit card, car loan, or normal mortgage, you always pay your *ALL* your interest first and a little bit of principal. The only time you compound your interest is if you get a negative-amortization mortgage. Then, your monthly payment does not even cover the interest owed, so you end up paying interest on your interest.

Also, note that the Rule of 72 is just that - a rule, not a formula. I believe that it underestimates below 4% and overestimates above that.

[Artfredo C. Abella, Ph.D. - LOS ANGELES, CALIFORNIA, U.S.A.]

Compound interest could indeed produce miracles since all interest earned by the principal or original amount would be added in the next computation of interest that it will earn. Let us cite an example, if $ 1,000.00 earns 3% annually after a year your original amount will be
$ 1,030.00, then if you do not touch your invested amounts in the ensuing year it will be
$ 1,060.90, on the third year it will be $ 1,092.27, so this is what Albert Einstein was saying that compound interest is one of the seven wonders of the world. The rule of 72 is a magic formula created since it provides the number of years where your capital invested will earn 100% profits, simple yet very effective. The best analysis made on the compound interest is that your earned interest earnings though small in the beginning will also earn interest earnings in the next succeeding computations if you do not touch the interest and the capital. This is the reason why they say your money is also your friend and/or your employee since it can work for you instead of against you. Money invested are like your workhorse or pool of employee creating wonders to earn more interest earnings for you. The rich people have only one rule make their money work for them while the middle class work for their money - they live in instant gratification, living pay check to pay check and spending their money on consumables. Always, the golden rule is to follow the advice of the Richest Man in Babylon - part of what you earn is yours to keep. In the west, we call it, pay yourself first by having automatic 10% deductions in your salary for savings or mutual fund investments or investment in stocks or bonds. Today as we see the economic recovery on the way we must exercise caution and follow strictly to the letter the miracles of compound interest because no less than Albert Einstein is a firm believer of this mathematical concept.