If you’re skimming your eyes through this article, it means you’re pretty passionate about increasing how much money or profit you currently have. You want a better life for yourself; you also want to learn how to improve your financial literacy and make it work for you.
If you have a business and you’re interested in learning how to multiply your earnings, then you would be shocked at this simple yet ignored law that can change your financial life forever.
First off, what is the law of compounding?
It is simply using the principle behind compound interest, which is the interest calculated on the accumulated interest over time as well as on your original principal. How do you explain little amounts of money here and there, snowballing itself into a big profit? Interests on interest. You don’t necessarily need to put in work to make it yield income for you. If you have an incredible knack for being patient, it just does!
Let me give you a more relatable example and shift the big terms aside. Assuming you earn a paltry sum of $100 a month and you make a decision to save and invest about $50 from your income every month for a period of 10 years and let’s say that investment gives 10% simple interest yearly, you would have a final amount of $10,518. You earned more than double of your original amount without working or lifting a finger. All you did was be consistent and patient. This is what differentiates the rich from the wealthy.
How To Calculate Compound Interest.
To calculate your compound interest manually, you need a formula of which I’ll provide you. I’ll also teach you how to calculate your compound interest with a realistic example. Get your pen and paper ready. Or your phone notepad. Whatever works for you.
If you’d prefer something fast and quick, click HERE to calculate your compound interest automatically.
For manual calculations, the formula for calculating compound interest is;
A = P (1+r/n) ^ (nt)
Where A = the future amount
P = the initial deposit or loan amount (principal investment)
r = the interest rate represented as a decimal
n = the number of times the interest is compounded per year
t = the number of years the money compounds for
Now for the realistic example, let’s say you invest $2000, which gives a 4.5% interest monthly for a period of 5 years. How much would you have accrued by the end of 5 years?
A = 2,000 (1 + .045/12) ^ (12 x 5)
A = 2,000 (1.00375) ^ (60)
A = 2,000 (1.25179)
A = 2,503.59
This means you’d have gotten an added sum of $505.59 as profit for saving and investing just $2000 for five years. What if you had invested more, may be added to your principal every month, how much do you think you’d have amassed as profit at the of the period of 5 years? I’ll leave that to you to calculate and see.
Why Does The Law of Compounding Sound Too Good To Be True?
Funny enough, the law of compounding isn’t all rosy and easy to apply. The benefits are usually the best parts of it, but you need to know its downsides so you can reap the best out of it by the end of your accumulated interests.
Yes, it takes an excruciatingly long while to get your stated profits back. But provided that you see what you stand to gain and stay focused on the long-term goal, you’ll be fine. The law of compounding isn’t a principle you decide to apply just for the sake of it. If you’re in a quick rush to get your profits back, this definitely isn’t the route to go.
You need to keep your financial goals in mind and remind yourself to keep yourself going, and make sure you don’t back out. At this rate, if you play your cards right, you can start saving by the age of 20 and retire at 45. This is the point where some financial literacy tips come in handy.
Factors that make your money grow faster using the law of compounding.
- This factor can’t be emphasized enough because it’s the most important. The earlier you start, the more interest you get overtime. Also, the longer you leave your money to compound, the more money you get. It is pretty simple. Suppose two individuals decide to operate the law of compounding with the exact same amount of principal but with five years and ten years period attached to those investments. In that case, respectively, we know the individual with a ten-year period of compounding will definitely accrue more profits. The time for your intended period of compounding matters.
- The interest rate involved.
- A higher interest rate means a faster compounding rate. Simply put, the interest rate placed on your principal and subsequently accumulated interests will determine how much more profit you’d be accruing as time flies by. The higher the rate, the better.
- Withdrawing and depositing your money.
- If you plan on compounding the right way and multiplying your original principal, it would be best to leave and not withdraw the profits of your money at different points in time over the stipulated period you plan to compound. Let your money do the growing. The more you withdraw, the fewer profits you make from your accumulated interests.
- Also, depositing more money always doubles the compounding effect on your money. Focus on doing more deposits than withdrawals to reap the best out of the principle. You would be amazed at what your profit would read at the end of your compounding period if you apply this factor correctly.
Advantages of the Law of Compounding.
- Compound interest has the ability to turn a small initial investment into a large profit over time. You don’t necessarily need to have so much money to start it out. All you need is determination, consistency, and time.
- With the law of compounding, you can improve your business strategies and grow a small business into a full-blown enterprise over a period of time. There are still a lot of real-life examples reeling from their decisions to indulge the principle behind compound interest. You can do this too!
- It ensures you’re financially literate due to the critical decisions you would have to be made on a daily basis. Going into the investment market isn’t something to be done without in-depth research and a proper understanding of the trends and statistics involved in it. This is where you would indulge in financial literacy, which would help you develop yourself, your business, and your financial responsibilities simultaneously.
- Compound interest makes your money grow rapidly because the rate of appreciation is determined based on the assets you earn over the years in addition to the initial principal sum. It ensures you are wealthy, as your initial investment and the gains that you have made increase together.
- If you are saving for your child’s education, the power of compound interest is unquestionably applicable. It helps you plan appropriately when making future preparations for family needs. Begin saving when your children are still in diapers, rather than when they are looking for a college to attend. Makes the hassle so much more easy.
- You can retire early if you apply the law of compounding diligently. Most wealthy individuals in our world today operate this principle at a much higher principle, but of course, they all started off small. It’s not too late to start saving and investing a good percentage of your earnings. By the time you’re older, your future is a whole lot financially stress-free because you paid the price early.
If you still are not so sure if the law of compounding is for you, maybe my story would help. I definitely didn’t think compounding would fit in with the amount of money I used to earn. It wasn’t much, to begin with. I worked two jobs, and taking out some money to save and invest for the future wasn’t an easy decision to make. But I was determined to make smart money decisions, and I forced myself to begin to see the end goal. Right now, I can boast of a substantial amount tied to my savings which were as a result of compounding my monthly savings being deposited there over the years.
Bottom line, compounding is powerful and something you should apply. If you are still not sure how to start out, you can read up some more articles on how you can effectively compound your money regardless of your current stage.