Today we will cover how compound interest will help in having the correct mindset when investing. After we have this core concept ingrained in our minds, we’ll see in what other ways it can help anyone, even if you are not planning to invest a single penny.
The core investing concept
Lets say you have an investing porfolio that can average an annual 10% return, awesome, you are making a return similar to the general market. Now you may be thinking, how is a 10% return going to help me in retirement? After all $1000 would only return $100, which in no way will help me retire and there is no way I can invest much more this year in the stock market. This is where compound interest steps in and takes care of the rest for you.
How compound interest works
You make your initial investment of $1000 in year 1. After 1 year you have made $100 if you had a 10% annual return. On year 2, you decide not to sell and you keep your $1000 invested for another 10% return which yields you another $100. If you had decided to reinvest your $100 in profit from year 1, you would have $1100 invested which would have yielded $110 instead of $100. If you reinvest this profit, on year 3 you make 10% on $1210 which is $121. As you can see, when you reinvest the profits, the amount invested and the profits grow exponentially, not linearly.
Some examples that will blow your mind
As you can see, compound interest has a dramatic effect on your porfolio, and that is why time in the market is the single most valuable key when investing. If you want to tinker with different ways of investing and different periods of time, you can google “compound interest calculator” as I am just using the number one search result which is the calculator from investor.gov.
How compound interest is applicable to life in general
What happens if we extrapolate these results to general aspects of life? People struggle to stay fit because they are not used to taking care of themselves so whenever they try to do any kind of exercise they will just exhaust themselves on the first day and never return. That training will have little to no impact. On the other hand, if you start by taking it easy (like walking a couple miles) you will gradually build up your body and it will eventually actually ask for several times more than what you initially started with. It takes years in the gym to see significant changes in your body. You will notice differences right away, but after a few years you will truly realize how big of a difference it really is. Not only that, but it will be very easy for you to stay in shape as it has become part of your routine. This positive impact in your life (that starts with very small changes) will leave you tremendously happy, and rightfully so because you are putting in effort and your quality of life has reached levels you could not have imagined.
Find personal ways to apply compound interest
Just as with getting in shape and stronger every week, you can apply compound interest to many aspects of life such as working on your personal hobbies (like getting better at chess), putting some time every week into starting a business, reading, expanding your knowledge (a personal favorite), etc. It’s up to you whether or not you find where to start applying the concept of compound interest to improve and become a better version of yourself. I will tackle some of these ideas of self improvement in other blog posts.