048: The Most Powerful Force on Earth — the Compound Effect
We’re all about the joy and wonder of passive income, also known as making money in your sleep. We’re dedicated to the cause of sharing the wealth so you can be the wealth. 💰
We talk a lot about how making your money work for you is one of the best things you can do for yourself and your loved ones. Building wealth through the powerful combination of time and selecting the right assets is key, and we’re going to talk heavily about one today, time.
Time ⏰ is the only resource we can never get back, is expendable and can never be returned. Although, we wish we could.
Yep, just ask our nighttime skincare routine! But the powerful force between time, investment amount and yield is what we’re trying to emphasize here. And it’s called compound interest‼️
Yes, the power of compound interest can best be described by some of the greats. Let’s get into it, shall we?
Albert Einstein once called compound interest “the most powerful force in the universe.”
Billionaire icon, Warren Buffet confessed, “My wealth has come from a combination of living in America, some lucky genes, and compound interest.”
Are you hearing what we’re hearing? These prominent historical figures have figured out what many have described as the 8th wonder of the world, compound interest.
Some of you, you have been in the game of compound interest and have seen the wonders it can produce. But time isn’t the only way to generate compound interest. For others of you, this may be your first time hearing about how magical math 🔮 can produce big benefits.
Either way, we’re glad you’re here. You may not know this yet, but your future self will thank you for listening to this potentially life-changing episode. And for applying ☀️ sunscreen every day!
Conveying the Compound
Ben Franklin himself described compound interest as “Money makes money. And the money that money makes, makes money.” No offense to Mr. Franklin, but we think we can do a better job at conveying what he’s trying to say.
To say it a bit more technically, compound interest is the interest on a deposit or loan that grows over time. And there are two types of interests when it comes to investing. 🤓🤓
The first one is called simple interest which grows your assets linearly, meaning the adding of interest is based on the original amount of money and not on the interest it earns.
Whereas compound interest grows your assets exponentially, meaning interest is based on the original amount and the accumulated interest.
Simple interest, for many, is the safer choice when it comes to borrowing money because you’re not paying interest on interest. Think back to when you were younger.
Maybe you grew up in a home where you asked mom and dad for $20 for a ticket to the movies, and maybe a quick bite to eat. Back then, $20 went a lot farther and mom and dad were not piling on interest fees for every $20 your teenage self borrowed.
On the reverse end of that, is compound interest. When you’re investing money, compound interest is what’s going to bring in the most reward for your investment. The way we look at it? Over time ⌛, you earn more money on top of your earnings because the interest builds on itself. That’s truly how to make your money work for you.
Take that same $20 and instead of spending it on normal teenage things, you stored it in an account that had high yield savings where you were gaining money every year at a certain percentage.
And you started as a teenager. Why is that something to note? Because the rate of growth for compound interest depends on the frequency of compounding. The higher number of compound periods equals greater compound interest. 😗😗
You and your money are both going to grow, except only one of you had an awkward phase.
So this brings us to the next question, why is this important?
The Compound Layers
One of the key components to the compound effect in terms of finances is knowing the three main levers that impact the compound effect. Those components 👉 are the investment amount, time, and yield.
Let’s start with TIME.
You may have heard that “with time” your money can grow x amount of dollars and feel hopeless. Who really wants to wait 30, 40, or 50 years before we have a saveable amount that would impact your life? 🤔🤔
This brings us to our arch-nemesis, the 401K which tells people you can’t touch or access your money in a timely manner. So they push this idea that compound interest will take a long time because the 401K also takes a long time to access.
Let’s pause there. You know how hard you work, and now you’re going to let the system tell you when you can and can’t access your money that you work for?
That’s going to be a no from us and sounds like no way we want to live. That’s why we preach what we preach 〰️ your financial wellness should allow you to experience your lifestyle dreams today and into the future.
Let’s break this down a little more practically and introduce you to our friend, Kristi. Kristi is a 40-year-old working mom of two. She’s a director at an ad agency and makes $100,000 a year. She loves what she does, but she’s also looking forward to retirement at some point in her life.
Her dream? Living in a renovated 1960’s home in 🌴 Palm Springs, California. We love a Kristi who works hard and has goals! But our girl is falling into a major pitfall, she’s using the rule of 20. This means she believes she needs to have 20 times her annual salary of $100,000. Totaling $2 million saved.
But, how will she get there?
Right now, Kristi is investing her money in a classic 401K that yields 4% annually and contributed $50,000 initially and then an additional $25,000 per year after that. With that math, how many years will it take Kristi to achieve $2 million at a 4% yield? 75 years! That’s right, Kristi won’t experience financial freedom until the ripe age of 115 years.
Those Palm Springs dreams are going to need to pivot. Or she needs to start listening to this podcast and invest in a passive income asset, STAT. And for these reasons is why we believe relying just on time for your compound effect is not efficient and a complete joke. 😞😞
While Kristi was made up to illustrate a point, the sad reality is, that similar scenarios like this happen all the time. And when people don’t know what to do, they start speculating or gambling with their wealth in hopes to grow their wealth.
That’s why for us, we’re big proponents of the great equalizer, the yield. 🙌
The yield when it comes to the compound effect is significantly more powerful because it can help you achieve your financial goals faster. Let’s get into what we mean.
How to Stay on the Good Side of Compound Interest
Compound interest is what separates the good from the great. Just look at Albert Einstein and Ben Franklin, two guys who weren’t going to take any risks with their money and knew the power of compound interest. And it totally paid off for them. Literally.
Staying on the right side of compound interest (AKA the money side) is essential. ✅
Soooo, how do we do it? We’re so glad you asked! To round out this episode we’re going to give you some thoughtful and tangible advice to get you on the good side of the compound effect.
#️⃣ 1️⃣ Save early to maximize the effects of compounding. Remember teenage you with $20? While you can’t go back in time and do something different with your money you can choose to start today. When investing, the earlier you start, the longer you have for that interest to work its magic on your wealth.
#️⃣ 2️⃣ Second, compare interest rates. Not all rates are created equally. This is where doing your due diligence (one of our favorite phrases around here) is crucial. Make sure you do a little research and shop around to find the best one for you.
#️⃣ 3️⃣ Up next is to pay off your debt as soon as possible. This topic alone can be a whole other episodeon, but for now, we’ll just stick with this: paying off your debt is a priority for the health of your financial future. Don’t stress… just do your best and keep chipping away!
#️⃣ 4️⃣ Lastly, if you must borrow, go for the lowest interest rate. It makes sense when you think about it, right? High rates are good for investing (because you make more) and low rates are good for borrowing (because you pay less). It’s all about doing what’s best for you. And ya know, thinking a little strategically. Work smarter not harder!
So this leaves us with one question for you: have you started yet? If not, consider this your sign. And if yes– we want to hear how this 8th wonder of the world has changed your life. ✨
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