“Get rich or die tryin’” urged American rapper 50 Cent, but there are easier ways of generating wealth than becoming a famous rap star and with less risk attached.
The simplicity of compound interest
One of the easiest methods known is relying on compound interest to grow your savings, with the more saved allowing your wealth to grow quicker. Put simply, compound interest is the interest paid on both the principal and any interest from past years.
Albert Einstein once described it as one of the most powerful forces in the universe:
“Compound interest is the eighth wonder of the world. He who understands it, earns it”¦ he who doesn’t, pays it.”
It requires leaving the original deposit in the bank and not making any withdrawals, with the interest each year adding to the original amount and thereby further growing the total return.
The rule of 72
The power of compound interest lies in the rule of 72. A bank deposit growing at 10 per cent a year in compound interest will double in value in 7.2 years, quadruple in 14.4 years and be worth eight times as much in 21.6 years. If the growth rate is 12 per cent, it will double in just six years.
To give another example, a $5000 deposit invested at a 10 per cent interest rate will grow to $5500 after a year. If no withdrawals are made, it will increase to $8052.55 after five years ”“ generating an extra $552.55 over this period.
The longer the money is invested, the greater the eventual return
The formula for compound interest is given as M = P (1+i)n, where ‘M’ is the final amount including the principal, ‘P’ is the principal, ‘i’ is the interest rate and ‘n’ is the number of years invested.
For example, $1000 invested for three years at a rate of 6 per cent compound interest would return a total of $1,191.02 (M = 1000(1 + 0.06)3).
The best way to become rich through compound interest is by starting early, investing often by adding to the original deposit, not withdrawing from the account and investing in the right assets.
If you have a problem with leaving funds alone, consider asking RaboDirect to put them into an account that cannot be accessed easily, and set up a system of automatic withdrawals. Then it’s just a matter of sitting back and watching your assets grow.
Now that’s something worth singing about.