Compounding interest is a concept that many people are familiar with, especially in the investing world, and it can most simply be thought of as “interest that you have already earned that is earning interest on itself.” Not only is this a valuable phenomenon when achieved with long-term investing, but can be extremely detrimental when the lender is earning compounded interest on you. (Yes, to no surprise, we are talking about debt!) Albert Einstein and Dave Ramsey do have this loose connection. We not only argue that long-term and disciplined investing is a key to retirement success, but also that avoiding debt to the nth degree is also a key, not only for financial success, but also psychological and emotional success. Albert Einstein called compounding interest “the 8th wonder of the world”, and also once said “he who understands, earns it… he who doesn’t… pays it.” To throw a little bit of high school-related math on the reader that might not be as familiar with the concept of compounding interest, understand that this is an exponential or parabolic concept not a linear one. Also reference this simple, and hypothetical example, that you may have heard of before as well. You have two choices... being handed one million dollars today OR receiving a “magical penny” that doubles in value everyday for 30 days… Which scenario are your taking?
To put it briefly, that “magical penny” will be worth over five million dollars on day 30. On day 20, you are looking at only a hair over five thousand dollars. What does this tell you? Good investments, a good plan, and discipline are all secondary keys to achieving compounding interest, whereas TIME is the most valuable asset of all.
So, if you are telling yourself that you will put aside money for tomorrow, or when you “get to that priority”, instead of today (disclosure: being debt-free outside of a mortgage is still a key here in our minds), you are putting yourself at a huge disadvantage. Here is a list of ten summarized and simplified reasons why compounding interest is so valuable:
1. It is the great equalizer – it does not discriminate and anyone can achieve this.
2. Momentum is utilized, and this can be psychologically and emotionally beneficial as well.
3. It can and does create Everyday Millionaires (EDMs).
4. Patience is taught – and you know that cliché about it being a virtue overall.
5. It lets you sleep good at night. (Just like a healthy emergency fund.)
6. It is your friend even if your income is statistically average or below-average.
7. It teaches and rewards discipline.
8. It separates those who are savers from those who do not save.
9. Allows for the creation of generational wealth.
10. It is not rocket science!
July 28, 2021
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