Webxcell Digital: Do you ever sit and think of ways to make more money without much effort? Or are you concerned about setting aside enough money for your retirement and your child’s training? Have you ever wished to have enough money to pay your bills? Well, the simple way to achieve all these things is to know how to make your money work for you. In simple terms, you need to understand the power of compounding and how to combine it with your investments.
What is compounding?
A lot of people have heard about the word compounding but do not know what it means. Well, the term compounding means that the primary returns that you earned on investment become part of the invested capital. Hence, compounding is a growth in the value of an investment owing to the interest earned on capital, and the accumulated interest.
The scientist and politician Benjamin Franklin says that compounding is that stepping-stone that will turn your lead into gold. For Jim Rogers, a financial commentator, and businessman, compounding is the magic of investing. With compounding, you can make your money work harder for you.
But the question everybody would want to ask is how then do you put your money to work? Do you buy any stock and leave and resell? Otherwise, do you invest and leave the money to grow? The simple answer to this question is in the power of compounding.
What Then Is the Power of Compounding?
The power of compounding is simply the secret recipe for gaining wealth or getting rich. It is the interest you earn on reinvested interest. To know what the power of compounding is, understand that there are two types of interest, compound, and simple interest. Simple interest is the profit gotten only on the money you save. But compound interest is what compounding brings to you.
With compound interest, you earn more money on your principal amount and the accumulated interest amount over successive periods. After a while, this profit mounts into a substantial amount. It is what we call the power of compounding. Even Albert Einstein calls the magic of compounding, which is to grow compound interest ‘the eighth wonder of the world.’
I know your mind is thinking and cooking up ways to make this work. Don’t worry, that’s where we are getting to.
How Does Compounding Work?
Let us find out how compounding works with the help of a hypothetical illustration.
Consider that there are two investors Evans and Henry. These two persons are looking for prospects and opportunities to generate more money with an initial investment of a hundred dollars. Now, they spot an opportunity where they can earn more interest at 15% per annum. Then they both decide to invest in the stock for ten years.
Evans chooses to calculate his interest as compound interest while Henry opts for his profit to be calculated as simple interest.
|Rate of interest||15%||15%|
|Period of Investment (in years)||5||5|
|Amount of maturity||$174.9||$160|
|The difference in the final value||$14.9|
From this table, we see that Evans accumulates a corpus, which is $14.9 higher than Henry. In this investment, the power of compounding is prominent in Evans investment because there was an addition of Evans interest in the previous periods in the next periods. It helped Evans increase his earnings. But for Henry, they calculated his profits on the initial principal for every period.
How Is Compounding Powerful?
Compounding is powerful because it can work to grow your interests in your investments. It makes compounding a compelling factor in your wealth creation. For example, when you decide to invest in a business, with compounding, your interest grows every day, and you get to increase your money. In essence, compounding is similar to how a multiplier works. You gain interest in your initial capital, which also earns a profit. Then, the value of your investment keeps increasing rather than staying stagnant.
Besides, compounding also helps you to repay loans. I guess that right now, you are thinking, how does this make compounding powerful? Well, it is simple. With compounding, you can pay half of your mortgage fee twice a month. For example, instead of making the full payment once a month, compounding will help you cut down your amortization period and save you a considerable amount of profit.
Interesting right? The question everyone should ask at this point is;
Incorporating Compounding Power into Your Investment.
Incorporating compounding into your investment is not that simple. But, with these few steps, you can put ‘man’s greatest invention,’ according to Albert Einstein, into growing your wealth.
- Start Early
Warren Buffet, one of the richest men in the world, started compounding at the age of fourteen. So, if you want to reap from the power of compounding, start investing early.
- Ensure That You Invest for A Long Period
To make your investment grow, you need to invest for as long as possible. It is because long term investments garner more interest than short investments.
- Invest More in Equity Markets
By equity markets, I mean a stock market. In an equity market, the shares of different companies are disbursed and traded in the market. So, if you want to take this power into your investment, invest in quality stocks.
- Learn Patience
To make more money, you need to be patient. Invest patiently so that over time you can reap healthy returns.
Though all these points are necessary, ensure that you spend more time on step 3. Investing in the equity market requires your time and effort, and you need to know what stock has quality.
The best way to take advantage of compounding power is to start investing wisely and as early as possible. If you start investing early, then the greater will be the power of compounding in your investments. So, you now know the power of compounding. You don’t need to be a monetarist or financial expert before you can benefit from the power of compounding. Why don’t you start investing? You never can tell where your wealth will come from.