Compound interest is how most people become wealthy or become trapped in debt. As such, it is crucial to understand this topic. In this video, we will be explaining compound interest for beginners.
So simply put compound interest is interest earned on interest very easy to understand there’s not a whole lot to it but it’s very important that you guys ingrain this in your memory and have a good understanding of how much wealth compound interest alone can build you so this is the interest earned on the initial principle as well as the accumulated interest of the
Previous periods so compound interest is the main reason why the rich get richer and money follows money so i know a lot of people pass those sayings around unfortunately it’s mostly poor people who say these things they will have a negative statement and they’ll say oh the rich are always getting richer and the poor people stay poor well if you want to understand
One main reason why the rich are getting richer it’s thanks to compound interest now compound interest is such a powerful concept that albert einstein himself called compound interest the eighth wonder of the world and the most powerful force in the universe and i’m hoping you guys after this module will understand why this is and then you can end up on the side
Of things where you’re one of the people who is building wealth through compound interest and not one of those people who’s saying negative things like oh the rich are getting richer the poor stay poor the poor stay poor because they don’t learn things like this they don’t learn what to do with their money to become rich and to build your wealth over time and one
Of the most important things you can do is invest in vehicles that will allow you to earn compound interest so this was a really interesting photo i found from i believe it was the calculatorsite.com so essentially if you want to compare no compounding to compound interest you can see the big difference here and this is showing the difference of compound interest
Versus no compounding for twenty years at a ten percent return so as you can see in just twenty years that one thousand dollars with no compounding grows to three thousand dollars whereas with compound interest it grows to over seven thousand dollars so this is the difference between compound interest and no compounding it’s linear versus exponential growth and
That is why it is so important to make sure you are investing in things that allow you to earn compound interest because otherwise you’re going to experience linear growth and as i’m sure you guys have seen or you’re about to see later on the exponential growth power of compound interest is really what’s going to make you rich so i want to give you guys an example
Here of compound interest which compounds over time versus simple interest so again with compound interest your interest earns interest but with simple interest it’s only your principal that earns interest so in example number one ten thousand dollars is invested at an eight percent return annually earning compound interest after fifty years so that’s without even
Investing another penny you would have four hundred sixty nine thousand sixteen dollars and thirteen cents now look at example number two here this is where you’re earning an eight percent return earning simple interest so you’re not earning interest on interest after fifty years you’ve only earned fifty thousand dollars so look at the difference there the difference
Between compound interest and simple interests is the difference of four hundred nineteen thousand sixteen and thirteen cents in this example here so that is why it is very important to make sure you’re investing in something that allows you to earn compound interest because this could be a half a million dollar mistake if you guys don’t follow these steps and
Make sure you’re earning compound interest with your investments and i know you guys are already probably saying how do i earn this what do i do to earn this well one of the best ways to do it is by investing in stocks with dividends that will allow you to reinvest those dividends that’s one of the best ways to earn compound interest and this is again this is why
People make the mistake of not reinvesting those dividends and you’re going to end up with a lot less money when you’re not reinvesting and earning dividends with those dividends over time if you’re getting those dividends mailed to you and you’re putting them into your slush account or just using them to buy groceries you are really really hurting yourself in the
Long term so now we’re going to touch on the rule of 72 so one of the easiest tools to see the power of compound interest is known as the rule of 72 and it’s very easy to understand guys this is a shortcut calculation used to estimate the number of years it would take to double your money at a given annual rate of return so what you do is you take 72 divided by your
Return and that tells you how many years it would take to double or how long it takes to go through a doubling cycle so the best way to use this calculation is to look at your life and say okay how long do i have until i realistically need my money so for example let’s say you’re 25 years old and you want to retire at 65 years old you have 40 years of time so start
Putting in some interest rates into this rule of 72 and we’re going to go over examples on the next slide here so i’ll skip ahead but start considering how many doubling cycles you could go through by looking at the rule of 72 and earning compound interest so even if you earn eight percent that’s every nine years you’re going to double your money so you’ll be able
To double your money over four times uh following that rule of 72 if you have 40 years to invest so that is a great way to determine how many doubling cycles you’ll be able to recognize as an investor so here’s just an example of this john is earning a six percent compound annual interest rate so he would take 72 divided by his six percent interest and that means
John will double his money every 12 years and i just made a little handy chart there for you guys ranging from 2 to 14 to give you an idea of how long it would take you to double using the rule of 72 so this should just paint the picture for you guys of the difference between low interest and high interest investments and how many doubling cycles you will see when
You’re looking at you know eight to ten percent return on your investment that’s you know you’re going to see a lot of doubling cycles over your lifetime especially if you are a young person okay so the next thing you guys are going to want to look into is the compound interest calculator now the equation for calculating compound interest is a bit intimidating if
You go on like the investopedia website you probably need to have a good background in mathematics to understand that equation so it’s way over my head i’m not really a math guy when it comes to that so luckily there is a much easier tool you can use to calculate compound interest yield and the securities and exchange commission has a very user friendly calculator
On their site if you search compound interest calculator i believe it is a first or second site it is a dot gov url so just google search the compound interest calculator and you guys can start playing around with this if you’ve never played around with a compound interest calculator that is the very first thing i want you to do after watching this module is sit
Down and put some numbers in there and start to see what compound interest can really do for you so the first thing you do on this calculator is put in your initial investment to your principal this is the amount of money that you have available to invest initially so maybe it’s ten thousand dollars maybe it’s twenty thousand dollars maybe it’s 500 it doesn’t
Matter what you start with all that matters is step two which is what you contribute each month i know a lot of people get caught up with the fact that they don’t have a lot of money saved up to invest you know they think they need to have ten thousand dollars sitting around before they get started but really you don’t need that all you need to do is to follow a
Strategy that makes sense and then follow something like dollar cost averaging into investments that earn you compound interest so it’s really not so much a matter of the initial principle it’s those regular contributions you’re making every single month so if you guys have an idea right now of what you think you’re going to be able to invest put that in step one
There your initial investment and then figure out what you’re going to do are you going to follow the self-imposed tax we talked about where you’re going to tax five to ten percent if not more of your income then go ahead and put that in step two and that’s going to be your monthly contribution and then below that you put the length of time in years that you plan
To save so again this comes down to what your goal is are you looking to have money by the time you’re 65 70 50 whatever it is determine how much time you have and then start putting these numbers in here and you’re going to get an idea of what you’re going to be seeing long term again usually if you’re looking at stocks historically over the last 100 years we’ve
Seen an annualized return of eight to ten percent so you can usually use those numbers to get a rough idea but remember that is over decades so you might have short-term corrections but in the very long term that’s what we’ve seen as far as a return goes from the stock market so step number three is where you’re going to input your interest rate to your estimated
Annual interest rate and i’ve never really used the tool below it but you can add a range of interest rates so a plus or minus if you want to add some fluctuations in there and then you’re going to be compounding this annually so then you’re going to hit calculate and hopefully at that point you’re going to be blown away by the results and understanding that you
Can become very rich and very wealthy without really burdening yourself too much in the short term all it takes is a little bit of discipline and those regular contributions over a long period of time without touching it or disrupting anything so let’s go over an example of this so let’s take a look at the eighth wonder of the world in action so as we said before
The average historical return from the stock market is around eight to ten percent over the last 100 years so for this example we’re gonna use eight percent so this person invests one thousand dollars of principal initially and then this person earns three thousand dollars a month after taxes so using that ten percent rule where you’re taxing yourself um they’re
Going to be investing 300 per month as a regular contribution so here’s where this gets really exciting guys this is what you would see as a return from that example so the first year they have four thousand six hundred eighty dollars in that account and really that’s a good amount of money but it’s nothing you know earth shattering it’s not really mind blowing
Yet well fast forward now we’re at five years now you have a portfolio worth twenty two thousand five hundred dollars ten years now you have over fifty thousand dollars in that portfolio now you’re starting to see your wealth build well fast forward to twenty five years you now have over a quarter of a million dollars you have two hundred seventy thousand dollars
After twenty five years of following a one thousand dollar initial investment with a ten percent self-imposed tax reinvested every single month after forty years you are almost a millionaire after forty years so if you are twenty years old right now forty years from now by the time you’re 60 years old if you follow the strategy and never increased it and remember
That most people are going to increase that self-imposed tax as they earn more money but even if you never increased it you have just about 1 million dollars in your account now if you were able to put that off for another 10 years you would be able to recognize another doubling cycle at that point following the rule of 72 and now 50 years later your portfolio
Was worth 2.1 million dollars now i know that sounds like a far distance off in the future i know most people think by the time they’re 70 or 75 they’re going to be old but i know a lot of 70 and 75 year olds who are still working because they really don’t feel like sitting around and doing nothing so it’s very possible you’ll be working into your 60s or into your
70s so i know 50 years from now i mean for some of you that are older you know time may not be on your side but as a young person this is the most important thing you need to understand is that right now time is on your side and i guarantee you if you talk to anyone who is older they’re going to say one of the things they wish they did was save more and invest more
When they were young and guys this is the main reason it’s due to compound interest if you’re 40 45 50 years old you’re at a serious disadvantage to the 20 year olds out there because time is not on your side as far as allowing your money to build and compound so i hope you guys are starting to realize what you can possibly do and what you can set yourself up for
And how you can build generational wealth at this point and just think about doing it for yourself but also for your children and their children building wealth that’s going to be passed down from generation to generation and it’s really not that hard guys this strategy is still allowing you to hold on to 90 of your income and you’re only investing 10 percent
So this is what you can see you can see millions of dollars being built up over time just by allowing your money to compound over a long period of time so here we have someone who’s a little bit more ambitious let’s say they have ten thousand dollars to invest initially and they earn five thousand dollars a month after taxes now they decide to invest 20 percent
Or impose a twenty percent tax on themselves so they’re going to be investing one thousand dollars each month now i know that sounds like a lot of money but when i was working my job that’s how much i invested every month i still had plenty of money to go out and hang out with friends and do things with my life but i was at the point where i was investing one
Thousand dollars a month so i know this sounds like a lot of money for some of you but if you start focusing on some of those things we discussed earlier cutting down on your expenses and maybe even earning more money you could get to the point where you’re able to invest something like a thousand dollars each month so after one year they have twenty two thousand
Eight hundred dollars still a very impressive amount of money but five years later they almost have a hundred thousand dollars after five years at year ten they have just under two hundred thousand dollars and by year twenty five they are just about one million dollars so twenty five years later you’ve become essentially a millionaire at that point now let’s say
They’re able to wait a little bit longer they wait 40 years by this point you have a portfolio worth 3.3 million dollars due to compound interest but again let’s say you started this young you were able to do this from the age of 20 or 25 and you saved until you were in your 70s if you were able to do this for 50 years you would have a portfolio worth 7.3 million
Dollars you have over 7 million dollars at that point that is enough money for the rest of your life that is enough money for you to have a very very nice life for the rest of your life and leave a lot of money for the people you love i mean this is what you’re able to do when you allow time to be on your side and again i just want to say this is what i this is
Why i’m stressing this for the young people because when you’re young especially like for me as an example i’m a young person most of my friends are not following things like this most of my friends are burning through money they’re buying cars they’re buying things they don’t need while they could be doing this with their money they could be building a future for
Themselves where they’re going to have a multi-million dollar retirement imagine this imagine having this on top of your 401k and other ways you can invest and and you’re going to be just you’re going to be set at that point you’re going to be set and maybe you want to work until you’re 50. you could probably do that following a strategy like this or you want to work
Until you’re older and just have millions of dollars to do whatever you want go travel the world you know or just be able to give money and help people with your money and do things for other people this is the power of what you can do by taking the time to do this and allowing time to be on your side and allowing yourself to build wealth over time and it’s just
It’s disappointing because i’ve shown stuff like this to my friends thinking they’re going to get inspired to do it and uh they don’t care they’re just like the future’s way off in the future they don’t even think it exists until they’re there and then once they’re there they’re going to be going wow i really should have followed these strategies and set something
Up where i could build money over time and unfortunately many people don’t realize that compound interest is very slow at first i mean in the first five years first 10 years you’re not going to see explosive growth but you need to leave it there for a very long time to be able to see these huge returns a lot of people refer to compound interest as the time value
Of money because you need to allow it to have a lot of time to grow so now that you understand the power of compound interest you are naturally wondering how do you earn compound interest so many refer to compound interest as the time value of money like i just said i kind of repeat myself because i remember little points where i added these things in and then it
Jogs my memory and then i go oh i already mentioned that but nothing wrong with a little bit of a reminder there but while it starts slow over time compound interest is a wealth building machine when you hear people talking about compound interest i want you guys to think about a wealth building machine they say that money machines don’t exist you can’t print your
Own money but compound interest is probably as close as you can get to printing your own money and having a money machine so one of the ways you can earn compound interest is through your bank accounts now this is not a good way to earn it but you can earn it through your bank account so your bank account allows you to earn compound interest because bank accounts
Pay an annualized percentage yield or apy which is the rate based on a compounding period of one year so a certificate of deposit or money market allows you to earn compound interest as well these are other things that may be available to you through your bank while this sounds like great news i know you guys are maybe jumping up and down with joel you’re ready
To go put your money in the bank and let it grow well the average interest rate from a bank account is 0.05 percent and most cds are under one percent so start putting that into your rule of 72 do 72 divided by one it’s going to take 72 years to double your money at one percent interest rate do it with a 0.05 interest rate that’s going to tell you how long it’s
Going to take double your money it’s not going to happen you’re not going to see these explosive returns unless you’re planning on you know living to be five or six hundred years old then maybe you can you know do this through your bank account so the bank is not a practical place to earn compound interest but it is a place that you do earn compound interest so i
Wanted to explain that so then we have bonds now do remember that most bonds pay a fixed interest sum or simple interest on the principal so if you’re earning simple interest you’re not obviously getting compound interest but a zero coupon bond allows you to earn compound interest so these bonds pay a certain amount of money at the maturity date and do not pay you
Interest in the mean time so essentially the bond is purchased for less than the face value and is worth the face value at maturity so one way you can earn compound interest is through zero coupon bonds but again you’re gonna find the yields are relatively low on those bonds because as we’ve said before bonds are a much more safe and conservative investment so my
Favorite way to earn compound interest is coming up next and as i’m sure you guys guessed is dividends so one of the best ways to earn compound interest is through dividends essentially you’re earning compound dividends so the best way to do this i’ve stressed this many times now is to set yourself up with a dividend reinvestment plan or a drip and this allows
You to earn compound dividend payments automatically i want you guys to focus on passive strategies and automating as much as you can and one of the best ways to do this is through a drip i mean imagine if you have regular contributions going into your trading account that you allocate into index funds that uh you know of blue chip stocks or individual blue chip
Stocks and then every quarter when you get those dividends they’re automatically reinvested into the issuing stock and you don’t have to do anything at that point it is completely automated i mean this is really what you can do you can automate everything that way you don’t have to worry about doing it or worry about forgetting it so essentially when you’re doing
This each dividend is used by more dividend issuing securities and dividend stocks allow you to earn compound interest while holding and appreciating underlying asset so not only are you earning compound interest on your dividends the underlying asset itself is appreciating this again comes down to the fact that as we’ve said dividend income stocks allow you to
Be paid in two different ways and by far dividend stocks are my favorite way to earn compound interest
Transcribed from video
Compound Interest Explained | Best "Interest & Dividend" Investments By Ryan Scribner