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Do you want to know how to become a millionaire by consistently investing a small amount of money?
Whether you are looking to save and invest $6,000 per year (that’s equivalent to $500 every month), or start off small by socking away $50 per month, you can develop good financial habits and become a millionaire, through the power of 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
I will show you how in an example later.
First of all, what is compound interest?
Now, I’m going to tell you a somewhat embarrassing story about me that will help you today.
Before you read on, do you want to know how we managed to pay off almost $100,000 debt and saved our first $100,000?
This first $100,000 in savings allowed us to invest our money to see exponential returns in our total net worth savings of over $700,000 all thanks to the concept of compounding interest!
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For the longest time, I had no clue what compound interest was. Despite being taught time value money (TMV) and the effects of compounding, I didn’t really nail that concept into that thick head of mine ’til many years later.
It was the summer of 2008 and I attended one of my boyfriend’s (today, my fiance) boring lectures in University. It was a financial risk management course taught by a tall Asian man in his mid-40s.
For goodness sake, what 20-year-old would want to sit in a three-hour lecture listening to some nerdy Asian dude blab about Monte Carlo methods, volatility forecasting models, Black-Scholes-Merton model, delta hedging, etc. etc.??
Ah, I probably lost most of you there already…
To be honest, I was only sitting in because I wanted to be with my boyfriend at that time. How pathetic, right? Hahahaha…
Not surprisingly, I fell asleep for the entire three hours.
It wasn’t until the last ten minutes before class ended, that the Professor’s speech caught my attention.
I’m not sure why he brought up the topic of TVM, but I vividly remember him saying, in his hilarious Asian accent:
“Ah, compound interest! This concept intrigues me SO much because it can make ANYONE rich over time!”
He went on explaining the mechanics of compound interest, but the “it can make anyone rich“ blurb was the only part I got out of it.
Even after teaching us how compound interest works, I still had no idea (that’s because I wasn’t paying attention).
Without getting into the math, compound interest is like pushing a snowball on a snowy day. It gets bigger and bigger as it accumulates snow.
Here, Wikipedia explains the definition better than the Professor:
Compound interest is 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, so that interest in the next period is then earned on the principal sum plus previously accumulated interest.
In the end, what the Professor said was true. Compound interest (even after inflation) can make anyone rich over time!
In fact, Warren Buffett will tell you that it’s one of the main ingredients that got him rich over the years. Although you may not become as rich as Buffett, it’s still a mechanic you can mimic with success.
The catch?
Well, you just gotta be patient!
I honestly wish I understood this concept earlier in my life. Now I’m blogging about this because I hope someone who doesn’t know will find it helpful.
Here’s how compound interest can benefit you. So, make him your BFF (best friend forever) today!
1) You don’t have to be a mastermind.
Yes, you can be a dummy and still become rich (not that I’m saying you are)!
From time to time, my fiance jokingly calls me a dummy. Yet, my investments have been compounding since the day I started investing.
As you can see, my fiance is the Brain in our relationship. You can guess who I am, right?
My fiance doesn’t see it and won’t admit to this, but he’s pretty damn smart (both nerdy and street smart). He’s the guy with high distinction on the dean’s list. He achieved an amazing CGPA. Particularly, economics, FINANCE, and business were his strengths.
At work, his team members and other stakeholders rely heavily on him and his inputs because of his brilliant ideas.
He knows his financial products and the business very well. If he’s crusty, all he needs is a quick review and it will become solid again. I’m trying to make a point and he’s going to kill me for writing all of this stuff about him. Oh well, too bad…
Overall, he’s bright and well-respected.
SO HERE IS MY POINT…
When we look at our investment accounts separately, he would tell me how jelly he is to see my money grow faster than his.
We both think it’s crazy because he earns 60% more than I do.
I know our time horizon is too short to tell, but here are some reasons why I think the dummy (me) ended up beating the smart guy (my fiance):
– more of my investments track the basic index (no fancy stuff here, I keep it simple)
– I follow the dollar cost average (DCA) strategy more than he does (that just means keep investing your money in automated installments regardless of the highs and lows)
– He tends to have more risky behavior than me
– He reads too much into markets and stock trends (I ignore the noise). This caused him to time the markets.
In addition to that, there was a time where he held onto too much cash and for too long because he wanted to catch the right opportunity. But I talked him into buying index funds. So, for some parts, he started a bit later than me.
My point here is to tell you that you don’t have to be some scholar to reap the benefits of compounding. Anyone can do this, but I know most won’t because they lack patience.
2) You don’t have to deprive yourself to reap the benefits of compound interest.
I’ve read SO many blogs where people write about cutting your daily coffees to reap the benefits of compounding.
For all those coffee lovers out there, are you really going to stop buying a cup or two until you reach 65?
You get my point, right?
Overall, saving is vital, but you gotta find the right balance. You want to enjoy life (not deprive yourself) while reaping the benefits of compounding.
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3) You don’t have to be Warren Buffett, Bill Gates, or Jeff Bezos.
In other words, you don’t have to be rich. If you’ve been following me, you will know that both my fiance and I came from low-income families.
Yeah…
🎵 we started from the bottom now we here… 🎶
Anyone a Drake fan?
Anyway, as mentioned above, Warren Buffett says compound interest played an important role in his success.
In one of my old posts, You Can Afford To Live Like This Billionaire, I wrote how Buffett started off by selling gum, pop, and newspapers door to door. At a very young age, he had an entrepreneurial mindset of buying low and selling high.
By the time he reached 11 years old, he invested in his first stock!
He admitted to making many investment mistakes, but overall, we know he didn’t start off rich. In fact, 99% of his wealth was earned after his 50th birthday according to Business Insider. He worked hard and smart, but time and compound interest were major factors in his success.
My highly recommended personal finance reads from Amazon. Click on the book to learn more:
4) You have time to build your friendship with Mr. Compound Interest.
The younger you are, the more time you’ll get to spend with Mr. Compound Interest.
So, be loyal and spend more time with him. Down the road, he’ll have your back and you will be thankful for the payoff (no pun intended here).
Any simple investment such as the S&P 500 is expected to compound over time when you set it and forget it.
Example of Pinky and the Brain. Who’s the loser?
To give you an example, let’s look at two scenarios.
Pinky
Pinky (me) starts saving and investing $6,000 per year at age 20 and stops when she reaches 30. At this age, she will never save another penny again. Just sit back and see how much her investment grows.
Brain
Brain (my fiance), on the other hand, starts later by ten years, at age 30. He wants to catch up to Pinky so he will save $6,000 per year until he retires at 65.
Suppose Pinky and Brain invest in the same index fund that yields 7% return annually, in nominal terms.
Pinky | Brain | ||||
Age | Investment | Expected Value | Investment | Expected Value | |
20 | $6,000 | $6,420 | $0 | $0 | |
21 | $6,000 | $13,289 | $0 | $0 | |
22 | $6,000 | $20,640 | $0 | $0 | |
23 | $6,000 | $28,504 | $0 | $0 | |
24 | $6,000 | $36,920 | $0 | $0 | |
25 | $6,000 | $45,924 | $0 | $0 | |
26 | $6,000 | $55,559 | $0 | $0 | |
27 | $6,000 | $65,868 | $0 | $0 | |
28 | $6,000 | $76,899 | $0 | $0 | |
29 | $6,000 | $88,702 | $0 | $0 | |
30 | $0 | $94,911 | $6,000 | $6,420 | |
31 | $0 | $101,554 | $6,000 | $13,289 | |
32 | $0 | $108,663 | $6,000 | $20,640 | |
33 | $0 | $116,270 | $6,000 | $28,504 | |
34 | $0 | $124,409 | $6,000 | $36,920 | |
35 | $0 | $133,117 | $6,000 | $45,924 | |
36 | $0 | $142,435 | $6,000 | $55,559 | |
37 | $0 | $152,406 | $6,000 | $65,868 | |
38 | $0 | $163,074 | $6,000 | $76,899 | |
39 | $0 | $174,489 | $6,000 | $88,702 | |
40 | $0 | $186,704 | $6,000 | $101,331 | |
41 | $0 | $199,773 | $6,000 | $114,844 | |
42 | $0 | $213,757 | $6,000 | $129,303 | |
43 | $0 | $228,720 | $6,000 | $144,774 | |
44 | $0 | $244,731 | $6,000 | $161,328 | |
45 | $0 | $261,862 | $6,000 | $179,041 | |
46 | $0 | $280,192 | $6,000 | $197,994 | |
47 | $0 | $299,805 | $6,000 | $218,274 | |
48 | $0 | $320,792 | $6,000 | $239,973 | |
49 | $0 | $343,247 | $6,000 | $263,191 | |
50 | $0 | $367,274 | $6,000 | $288,034 | |
51 | $0 | $392,984 | $6,000 | $314,617 | |
52 | $0 | $420,493 | $6,000 | $343,060 | |
53 | $0 | $449,927 | $6,000 | $373,494 | |
54 | $0 | $481,422 | $6,000 | $406,059 | |
55 | $0 | $515,121 | $6,000 | $440,903 | |
56 | $0 | $551,180 | $6,000 | $478,186 | |
57 | $0 | $589,763 | $6,000 | $518,079 | |
58 | $0 | $631,046 | $6,000 | $560,765 | |
59 | $0 | $675,219 | $6,000 | $606,438 | |
60 | $0 | $722,485 | $6,000 | $655,309 | |
61 | $0 | $773,058 | $6,000 | $707,601 | |
62 | $0 | $827,173 | $6,000 | $763,553 | |
63 | $0 | $885,075 | $6,000 | $823,421 | |
64 | $0 | $947,030 | $6,000 | $887,481 | |
65 | $0 | $1,013,322 | $6,000 | $956,024 |
Results of Pinky and the Brain
As you can see, Brain may be smart, but he cannot beat the power of compound interest. He invested for a total of 36 years. On the other hand, Pinky invested for 10 years only. Yet, he’s still behind her by $57,297.
Who’s the loser now?
Summary | Pinky | Brain |
The Age Pinky/Brain Starts Investing | 20 | 30 |
Investment | $500 per month | $500 per month |
Years of Investing | 10 | 36 |
Total Investment | $60,000 | $216,000 |
Rate of Return | 7% | 7% |
Expected Value on their 66th Birthday | $1,013,322 | $956,024 |
Overall, my point is that time becomes your best friend, especially when you start developing a relationship with him in your early years.
But even if you’re in your 40s, don’t fret! You still have time to become good friends with Mr. Compound Interest. The best time to become friends was yesterday, but the second best time is now!
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5) Mr. Compound Interest is your cute little minion.
Did I mention earlier that he’s got your back?
Yeah, just don’t abandon him half way and he’ll stay loyal to you. He will eventually work harder for you at growing your money compared to you putting in the time and effort to make/save your money.
With that said, compound interest is passive — just like the other forms of passive income ideas I list here (you should totally give those a try too)!
So, hang on tight, buddy… he’ll shower you with lots of love one day. You just gotta give it some time…
Summary
There you have it — how this secret weapon, compound interest, will work for you (again, no pun intended here).
In sum, you don’t have to be a finance wiz or Warren Buffett for that matter.
You also don’t have to deprive yourself of fun while reaping the benefits of compounding interest.
All you have to do is be smart with your savings, start early, and become best friends with him.
Over time, your minion will work harder for you than you work for yourself. Isn’t that amazing?
The only catch is, you gotta be patient — just like how you’re patient with your other long-term friends. Though, I wouldn’t call your friends minions, LOL. But like any other good ol’ friendship, it pays off really well in the end! 🙂
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Did you enjoy this post? If so, don’t forget to share it on Pinterest! 🙂
MrDoublingDollars
It’s so simple but people are impatient!
Do you think it is human nature to try and beat the market? The dream of ‘striking it rich’ and all that? (Maybe it is why cryptos are so hot right now)
panda
Whoever can be patient will reap the HUGE rewards 🙂
Crytos can make you rich. But those who banked their entire life savings (ya, we’ve all heard crazy stories) don’t know what they’re getting themselves into… 😐
Kris
Great explanation of compound interest. I wished I knew the concept of it as well when I was going to school or else I would have invested at a younger age.
Hopefully more people know how compounding works, like you said it you don’t have to be a wiz to get the concept of it.
panda
Hi Kris!
Yeah, I feel that any person who understands it will wish they knew sooner. Those that don’t won’t really care, haha!
I honestly wish I could talk to everyone in their teens to early 20s about compounding, but they will think I’m nuts. Even some people in their 30s or even 40s don’t know this. Those that know it and use it will be rewarded BIG TIME 🙂
Sean @ Frugal Money Man
Excellent post about our BEST FRIEND…Mr. Compound Interest:)
My fiancée struggled (actually still yells at me sometimes) when I force us to load up our index funds for the year before we begin to save for our other big goal purchases, but it’s because of compound interest. It may not be fun in the short term, but anyone who has ever experienced Compound Interests BIG effects later on in their investments, understand how important it was to start early. That snowball will be way bigger than you could have ever imagined when you finally begin to play with it!
Great post!
panda
Hey Sean!!
hm… they always say happy wife, happy life 😀 hehehe
Yes, anyone can see the huge effects later on in life if they become friends with Mr. Compound interest from a long time ago.
It’s also important to have some fun at the same time. Balance is key and I’m sure you and your fiance are already setting a good balance! Both are you are already ahead of the game for starting early. Keep it up, man!! 😀
GYM
That’s a really cute picture of BFF’s!!
Awe you hold your fiancee in high regards, he should be proud that you are speaking so highly of him (except your portfolio is doing better!)
Great explanation of compound interest, bringing back Pinky and the Brain that was the best cartoon!
fin$avvy panda
Hey GYM!
Thanks, when I was browsing, I thought it would make a nice pic. I don’t think anyone thinks of Compound Interest as fun, cute or happy so I thought it would a good one to use for such a “boring” topic.
Lol, my fiancé killed me… he found out and said to not write the good stuff about him haha >.<
And yes… pinky and brain are so adorable 😊
Money Hungry
People let me tell you bout my best friend!! Awesome post Ms. Savvy! It’s crazy to think Brain would have less money after so many years of investing, but the numbers don’t lie. Start Early, even if it’s a small amount. Let CI do the heavy lifting.
-MH
fin$avvy panda
Hey man who’s hungry for money lol!
Glad you enjoyed the post.
Yeah it’s crazy when you look at the numbers but math doesn’t lie!! Einstein doesn’t lie! Haha let money do your work 😉😉
Steve
Great post, compound interest is amazing ! I have been teaching my kids about starting early and saving on a regular basis. I will get them to read your post.
fin$avvy panda
Hi Steve! That’s awesome that you’ve been teaching your kids! What a great parent you are 👍
Thanks for mentioning my post to them. Hopefully they won’t be bored about the topic hahaha!!!
Thanks for stopping by. I can’t wait to check out your page 😊
Caroline
Great way to explain compound interest , simple and easy to understand! I will make sure to share this post with both my daughters:)
fin$avvy panda
Aww thanks for sharing with your daughters. I hope it helps them and that they will be friends with Mr. CI it as early as possible! Lol 🙂
Leo T. Ly
Compound can work for you if you invest your money wisely. On the other hand, if you spend frivolously and rack up all those credit card bills, compound interest works the same way. This time it’s against you.
Don’t choose the wrong BFF.
fin$avvy panda
Lol yes, we shouldn’t choose the wrong bff. The other side is a devil. He’s bad influence and will have you behind… yikes! >.<
Tom @Dividends Diversify
Ms. Panda, I heard Warren Buffett referred to once as the ayatollah of compoundola. Good enough for Warren, good enough for me. It’s silly, but it has always stuck with me. Tom
fin$avvy panda
It’s one thing you want to stick with for the rest of your life! There’s no mistake with that decision. Hehe 🙂
Mrs. Defined Sight
I feel that anyone who reads this post will realize they too can be friends with Mr. Compound Interest He definitely loves to love, is loyal, and share the wealth…so yeah, why not be friends with Mr. CI?!
Did I miss it anywhere else – or is this the first Bitmoji of Mr. Fiance?! I knew he was illusive like Mr. DS…glad he came into the picture!
Speaking of Mr. DS, he knew who Drake was when I asked the other day, “Oh yeah, he’s really big.” Oops, am I missing out?…my amazon prime station is still on 90s grunge…
Great post, layout of numbers and summary! Keep it up!!!
fin$avvy panda
Lol yup! First time I used his Bitmoji! Yes, let’s all be best buds with Mr Compound Interest hehe 😊