Compound Interest
If you're reading this, it's because you're vaguely interested in how rich people become rich. As a person that is in the process of becoming rich,I have absolutely no problem divulging any secrets of how it's done to anyone that wants to know. I enjoy teaching, and furthermore, you learn a lot when you yourself teach.
The first thing I want to talk about is the most basic element of wealth building: Compound Interest. Compound Interest, as Einstein said, is the strongest force in the world. Why so many people end up in debt is because they get on the wrong side of Compound Interest. The Credit Card companies do not make it any easier: They design their bills to have only the minimum payment made so they can compound interest against you.
Let's look at compound interest in effect. Suppose you charge $1,000 to a credit card and never pay it off. For illustrative purposes, let's pretend the credit card company won't come after you but will instead simply charge you interest every month diligently. If the credit card has a 20% APR, after year one you will now owe $1,200-- $200 worth of interest has been recorded against you.
The next year, however, you will not owe $1,400-- you will owe $1,440, because your interest is calculated including the interest from the former month. Let's see how quickly this develops against you:
Year 1: $1,200
Year 2: $1,440
Year 5: $2,488
Year 10: $6,191
By Year 10, you owe over 6 times the original amount. By compounding the amount, you now have to pay $5,191 worth of interest-- or 519.1%. So that 20% rate? It's actually more like a 51.9% rate by year ten.
Compound interest can be dangerous, but it can also reward those who understand it.
Now, assume you have an investment that gets you a 20% return annually. This is not impossible--if you find a good rental property or small business, a return like that and above is certainly possible. If you compound that return over the course of, say, 40 years, a $1,000 investment would be worth roughly $1.5 million.
Thus, if you get anything from this entry, know this: Start early, avoid investments that do not provide you immediate, tangible cash flow, and always have compound interest in your favor.
The first thing I want to talk about is the most basic element of wealth building: Compound Interest. Compound Interest, as Einstein said, is the strongest force in the world. Why so many people end up in debt is because they get on the wrong side of Compound Interest. The Credit Card companies do not make it any easier: They design their bills to have only the minimum payment made so they can compound interest against you.
Let's look at compound interest in effect. Suppose you charge $1,000 to a credit card and never pay it off. For illustrative purposes, let's pretend the credit card company won't come after you but will instead simply charge you interest every month diligently. If the credit card has a 20% APR, after year one you will now owe $1,200-- $200 worth of interest has been recorded against you.
The next year, however, you will not owe $1,400-- you will owe $1,440, because your interest is calculated including the interest from the former month. Let's see how quickly this develops against you:
Year 1: $1,200
Year 2: $1,440
Year 5: $2,488
Year 10: $6,191
By Year 10, you owe over 6 times the original amount. By compounding the amount, you now have to pay $5,191 worth of interest-- or 519.1%. So that 20% rate? It's actually more like a 51.9% rate by year ten.
Compound interest can be dangerous, but it can also reward those who understand it.
Now, assume you have an investment that gets you a 20% return annually. This is not impossible--if you find a good rental property or small business, a return like that and above is certainly possible. If you compound that return over the course of, say, 40 years, a $1,000 investment would be worth roughly $1.5 million.
Thus, if you get anything from this entry, know this: Start early, avoid investments that do not provide you immediate, tangible cash flow, and always have compound interest in your favor.
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