The Magic of Compound Interest

How to Differentiate Rich from Poor

Most of us don’t believe we have any difficulty distinguishing rich people from poor, but a definition that may give you a chuckle goes as follows:

“You can tell those that have from those that don’t by the fact that the rich plan for the third generation, whereas the poor plan for Friday night.”

Besides being a bit of a laugh, there is a little truth in the statement.   The rich have realized that instead of blowing it all on Friday night, they should keep a little back for the proverbial rainy day.  But they have also learned about Compound Interest, allowing the money they do keep back to grow at a surprisingly fast rate.

Most people I have associated with in life have been hard working stiffs like myself.  People, who go off to work in the morning, come home exhausted in the evening and every two weeks or so get a paycheck for their labor.  But, after the rent, car payment, food, cloths for the kids and taxes, there is precious little left to go out Friday night let alone to save. 

Keeping a little back

It was my Mother, the person who looked after the paychecks in our family, who taught me how to approach the subject of saving, to ensure there was something to fall back on when times got tough.  She would take out what she wanted to save first, usually about five percent of the family paycheck.  In this manner she was not tempted to spend everything that came into the house.  She would then budget all the family expenses on what was left over.

Making it grow

However you decide to budget, if you can put away say $100 a month, and are able to invest it at 8%, through the magic of compound interest, you would have $18,780 in ten years.  This assumes the compounding would be done annually.

Simply put, compound interest is paid on the original amount you put away and on the accumulated interest you receive each year.  Compounding is usually done on an annual basis but can be done daily, weekly or monthly.  Generally speaking, the more times an amount is compounded, the more money you will earn from your investment.

You may be able to put away more or less than the example I have given above.  Whatever the amount, you don’t have to be a mathematician to figure out what its future value would be.  There are many interest calculators on the Internet that can make the calculations for you.  Try out a number of scenarios.  You may be richer than you think

Remember

Just remember, the same principle of compound interest works in reverse with mortgages and other forms of loans, and is the reason why many people are surprised to find how much they have paid in interest to settle a loan.

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