If we want to do something big in our lives, we have to do something small, every-day.
We can’t all become the next investor billionaires like Warren Buffet. But no matter how much we earn, we can use the power of compounding to create the wealth in our lives that we never thought was possible.
If you have €1 and double it every year, how much do you have after 20 years?
It would go like this:
Year 0. €1
Year 1. €2
Year 2. €4
Year 3. €8
Year 4 €16
Year 5 €32
Take a guess how much it would be after 20 years.
Year 7. €128
Year 8. €256
Year 9. €512
Year 10. €1,024
Year 11. €2,048
Year 12. €4,096
Year 13. €8,192
Year 14. €16,384
Year 15. €32,768
Year 16. €65,536
Year 17. €131,072
Year 18. €262,144
Year 19. €524,288
Year 20. €1,048,576
That;s the incredible power of compounding. Now I know that no investment is going to make us 100% returns for 20 years. But it’s crucial to be aware of the impact compounding returns can have on our lives.
‘’Compound interest is the greatest mathematical discovery of all time’’. – Albert Einstein
Compound interest in the reason we all need to start investing… NOW! Not next year, not when you get your raise, TODAY! For every year we delay investing, we are losing out on another years potential compounding interest. When we buy things, it helps to stop thinking of how much it will cost but instead think of how much we will lose over the long term if we don’t invest this sum of money TODAY.
In my mid twenties the last thing I wanted to think about was investing or taking out a pension. It just seemed so far away! I couldn’t relate to it. I needed the money today for doing fun stuff! But when it comes to creating wealth over the long term, its not the person who invests more that makes the most money, its the person who invests FIRST.
Lets look at the example of two twin brothers. James and Paul have just turned 65 and hit the retirement age. James started investing at age 20. For the next 20 years he invested €4,000 a year (€333 a month). So he stopped putting in any additional money at 40 and just let it grow. Let’s say he made a rate of return of 10% a year and that the money was in a tax free environment.
Paul started investing when James stopped, at 40. He also made €4,000 contributions a year but he invested for 25 years until aged 65. He also made a 10% return and the money grew tax free. James invested €80,000 in total over the 20 years. Paul invested €100,000 over 25 years.
So which brother had more money when they reached retirement age??
Even though Paul has put 20% more of his own money into investing, James has destroyed his brother in terms of return. HE MAKES 634% MORE!! 6.34 TIMES MORE
At age 65:
You can imagine that the two brothers are going to have very different types of retirements…
The key here was that James had 20 years more of compounding than Paul. By the time Paul started investing at aged 40, James had already turned his €4,000 a year into €278,920. So even though James completely stopped making contributions from that point, he now had €278,920 to make compound interest on for another 25 years! The result is that by the time he retired he was a multimillionaire.
The crazy thing about this is that we aren’t talking about ridiculous sums of money here to invest. If we really needed to, most of us can save €4,000 a year. When we look at things like this, we realise that the wealth we dream of maybe isn’t so far away at all. That we can achieve it, but we need to start ASAP! For each year we delay, we lose another valuable year of compound interest.
What tends to happen we people see these numbers is that they just wish they knew this earlier in life and started earlier! If you are 60 now you wish you started at 50 for an extra 10 years compounding. If you are 50 you wish you started at 40! If you are 30 you wish you started at 20! But the fact is we didn’t have this knowledge earlier so we can’t mpact it. However… What we can impact is the future. And we can do this by starting TODAY!
How would you turn €4,000 a year in €1m?
If we used the same conditions as above and you started investing €4,000 a year at 10% return at age 20. By 52 years old, you would be a millionaire….