Sunday, January 16, 2011

Reproduced : Power of Compound Interest

This was my guest post on my buddy's blog :- - A quintessential guide to Russel Peters says : Be a Man! (do the right thing!)

I was guest posting trying to convince people that the time to start saving & investing is now... and why? The power of compound interest is why! This is the
1st Part of my 3 part series of guest posts on his blog. Read on!

Compound Interest here we go!

The Power of Compound Returns
This is the First Part of a Three Part series on “Getting Started to Managing Your Finances” by Joe. Yes, he’s your average Joe and he’s probably in not much better shape financially that you are but hey, you can’t blame a man from trying, no?

First off, if you’re reading this you’re probably in your 20s maybe 30s and sharp, good looking and having not too bad of a time with the opposite sex, thanks to Straight Guy (and Gal now!).

But have you thought to yourself – I don’t have enough money! I wish I was earning more money!

Sure, you can get a new, better paying job - but I'm not here to interview you for a job opening - instead what I'm here for is to share some basic skills and knowledge that everybody, and I mean everybody, should have. Managing your finances, as they call it - to make more money with what you already have.

For my first part, I want to share a very simple concept before diving deeper into the art of managing your finances. It is not only an essential concept but indeed one that is very powerful and handy to know.

It was Albert Einstien who said : "Compound interest is the eighth wonder of the world. He who understands it, earns it ... he who doesn't ... pays it."

If the world’s smartest man to have ever lived said that, boy, don’t we all have to sit up and listen what he has to say! But wait - just what does this "compound interest" mambo jambo mean in real life?

It means two things.

First of all, it’s a powerful tool to make your money work harder for you. It’s funny how we all work so hard for our money, and yet never have given thought to how it can work harder for us.

Let me give you a quick and simple example.

I. Love. Coffee.

I love it so much that every single day in the year I spend RM9.50 on a grande Cappuccino at Starbucks. Doing the simple math of RM9.50 x 365 = RM 3467.5 (assuming it’s not a leap year).

Now, how much do you think I'd save annually if I had taken that money and put it into a fixed deposit account instead (with say 5% interest per year and the interest is left in the account to accumulate – ie: compound interest.)?

Doing the math, by the end of the 20th year, I would have RM 114,656!

Okay, but what if I'd just saved that money in a jar under my bed? (that would be a lot of jars!)

RM 3467.5 x 20 = A mere RM 69, 350.

Thanks to compound interest, I'd have effortlessly made myself an additional, sweet RM 44k!

What compound interest can do to a man.

This in turn, leads me to introduce the Rule of 72.

If you had a fixed amount of money and you wanted to calculate how many years it would take to double it, just divide the rate of your returns against it.

For example, you have a fixed deposit which gives you a returns rate of 6% per annum. 72/6 = 12 years for your money to double.

This rule also works if you want to calculate the returns rate which you need to double your money in a certain number of years - e.g. say 6 years which is 12%. (72/12 = 6 years)

However, the only downside to the above is this rule is less useful if the number that divides it is 20 or above.

So, what now?

With that realization, I hope you've come to understand two things - It is worth saving and investing money here and now!

1) Start early.
Use the power of compound interest to make your money work harder for you. Each ringgit saved is akin to a "biblical mustard seed" if invested well.

2) Don't Take too Much Debt.
Conversely so, you should avoid raking up excessive credit card/personal loan debt as this is the flip side of the compounding interest action, making you poorer and the banks all the much richer!

That is all for now. Look out for my 2nd part of my guest series on the HOW to manage, after we've dealt today with the WHY. Until next time!


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