Compound Interest in Action
first why investing is even important in the first place. So we have three key reasons, and a big one is compound interest. One of my favorite quotes allegedly, Albert Einstein said it. It's that compound interest is the eighth wonder of the world. He who understands that earns it. He who doesn't pays it. Many of us have been on the wrong side of compound interest when we have debt. But compound interest in its simplest form, is the idea of earning interest on your interest. It creates the snowball effect. So in a really simple example, let's say, this year you invested $1000 it earned a nice return of 10%. So at the end of the year, you have $1100 in year two. What's going to happen is you're now earning interest on that $1100 not just the original $1000 that you invested, so it's earning interest on your interest. It's the snowball effect that works for you when you're investing, works against you when you're paying off debt. So that feeling of how is it that I'm putting $400 a month...
towards my student loans, and this never seems to go down. That's compound interest being the bad guy. So let's give it a more specific example. So in January of next year of 2020 you are going to put $1000 into an index fund, and each month after that you're going to put $100 a month into this index fund. And you're going to do that for 20 years, $100 a month for years and you're gonna get over that 20 years, an average 7% return on your investments. What I mean by that is some mark. Some years the market's gonna be great. Maybe you get a 12 15% return, and some years it's gonna be crappy. It could even be negative. But on the whole, over this 20 years, we're going to see you got 7%. So by December 31st 2040 you have accumulated just shy of $50,000 in this investment. What if you just saved $1000 as your initial investment and then put $100 per month in there and said we're not investing in this case we're saving? You'd have about half $25,000 depending on the interest rate. Your savings account would fluctuate a little bit, but this is a wonderful example of how when you invest your money is doing some of the heavy lifting for you. This is the exact same behavior. But in one case, you an investor in one case, you're just saving. So I asked every expert I interviewed for my book. What is the biggest mistake that a rookie investor can make when it comes to investing? And almost every single person said not starting early enough. Time is our greatest asset in our lives as investors, but a lot of times we procrastinate, procrastinate, procrastinate because they're coming up with various excuses about why we can't get started.