How to earn compound interest 3 different ways in 2020?
How to earn compound interest in 2019? I remember asking that very question when I first learned about compound interest. After doing hours of research and reading countless articles, I put together 3 ways you can earn compound interest in 2019.
Let’s us first start with compound interest definition and example, after that I will show you how to earn compound interest 3 different ways in 2019.
Many say compound interest is the eighth wonder of the world? “Compound interest is the most powerful force known” as per Albert Einstein and you know he was right. Compound interest is a concept that overtime your money begins to make you money when the interest compound on your principal.
I’m going to use student loan as an example as it is particularly prevalent in my generation. Student loans are generally paid out over a 10-year, 120 months, window. Assuming that you don’t pay them off early and you have fairly average interest rate hovering around 4-4.5%, you will have paid $9,170 interest on your $40,000 principle. That’s an average of $76 a month just on interest payment.
Rather than paying interest, let’s say you put this $76 in the market at 8% rate of return, you would end up with roughly around $14,000 if the money had been working for you and not against you in 10 years. I don’t know about you but an extra $14,000 sound pretty good to me. Compound interest is an amazing tool if used correctly and it can work wonders for you especially when it’s combined to something like a concept of a high savings rate.
Compound Vs. Simple Interest:
In this article, we’re going to be talking about compound interest, what exactly compound interest is, and how you can earn compound interest. There are two types of interest you can earn, simple interest or compound interest. Just based on the name itself, you can probably guess that compound interest is the interesting one and simple interest is old and boring.
So you either have simple interest or compound interest. With compound interest, you’re able to earn interest on interest. But with simple interest, it is just the interest on your initial principle amount or deposit. Let me go ahead and give you guys an example of this using numbers. That way it makes more sense what I’m talking about.
Let’s say you invested $10000 and you were earning 10% per year of simple interest. You would earn $100 in interest every single year. Year one would be one thousand dollars, year five would be one thousand dollars, year twenty three would be one thousand dollars. Every single year you’re earning the same amount of interest. Regardless of time, your interest never bring more interest back. In 30 years, account would grow in value from $10,000 to $40,000. Overall, you earned $30,000 in the form of interest payments.
Now, let’s look at the compound interest. Compound interest is very powerful, it allows you to earn interest on your interest. If you had that same investment of $10,000 at 10%, but earning compound interest over 30 years. Your account would grow to $193,581.5 instead of $40,000. That, my friend, is a big difference. I have attached a compound interest calculator here for your convenience.
Now, you can see the difference between simple and compound interest and the power of compound interest. With simple interest your earning was fixed at $1000 a year every single year. However, with compound interest you earn $1000 the first year, $1100 the second year, $1210 the third and progressively more every single year.
How is this possible?
It is possible because you’re earning interest on that interest you earned year before. In the first year, you’re going to earn 10% on your original ten thousand dollars. Second year, you’re going to earn 10% on your original ten thousand dollars as well as on interest from previous year.
I know it’s kind of a complicated concept to understand but really all you have to understand is that it is interest being paid on your interest. This allows your money to grow at an exponential rate, and not a linear rate.
Linear rate is a straight line, it is a gradual growth at the same pace. If you have ever seen an exponential growth curve, I’m sure you know it starts off slow. But it begins to grow at an even faster rate as more time passes. This is something that we call the snowball effect. With compound interest you’re gonna be taking advantage of the snowball effect. What that means is that these small and seemingly insignificant results are going to have a massive effect or massive change over time.
Years of compounded interest will have massive effect on your savings and on your investing account. But it can take long period of time. This is the reason reason why most people are not interested in compound interest. You have to have a lot of patience, you have to understand this is a long-term investing strategy and you’re gonna see most of the fruits of this years down the road.
In 10, 15, or 20 years down the road, people who are patient and understand the true power of compound interest you can reap the benefits. But, for people who are impatient and can’t see the long-term picture, they’re gonna end up wasting a lot of time. They’re gonna wait until later in their life to begin investing. I’m sure you guys can understand this. If you want to take advantage of compound interest, the best way to do that is to start early. Best thing you can do is to give yourself more time to save and invest. Lot of people refer to compound interest as the time value of your money, not just much money you’re investing. It’s really about how much time you’re allowing your money to grow.
Benefits of Starting Early
Young people are at the biggest advantage because they have the most time to allow their money to grow the most amount of time. They can allow themselves to earn interest on interest and as a result, they can earn the most money through compound interest.
If you are young, scared, or skeptical about this, than ask someone with experience or financial literacy “what you should do in your 20s?”
I guarantee you most of them are going to say save more money and invest that money. In fact, the most successful investor, Warren Buffet, once said key to his wealth is compound interest.
Now you understand what compound interest is and how it can help you gain wealth, next is to understand rule of 72.
Rule of 72
Rule of 72 will help to calculate how long it will take to double your investments. We know key is to let investment sit and accumulate for years. The best way to visualize these interest rates is to figure out how long it would take to double your money at given interest rate. You can calculate this very easily by looking at something called the rule of 72.
What that means is, if you take the number 72 and divide it by your interest rate, that’s going to tell you how many years it’s going to take to double your money at that given interest rate.
3 Different ways to earn Compound Interest
Finally you made it. Now, let’s discuss how to earn compound interest 3 different ways.
3. Through Banks Investment
First of all, one way you can earn compound interest is through your bank account. Through a savings account, through a checking account, through a money market account, or through a certificate of deposit.
Now, you might question is this a good way to earn compound interest? Absolutely NOT, you will not even outpace inflation when you’re earning compound interest through a bank account.
I would not recommend doing this with your money. Don’t put your money in the bank and think you’ll become a millionaire through the interest earned from your checking or saving accounts.
If you guys don’t believe me, go out there and ask a millionaire how much money they made from their bank account? They will laugh at you and say they invested their money in the stock market or real estate or something else with much higher return. Let’s get into these bank compound interest opportunities.
Bank’s Checking and Saving Accounts
The average checking or savings account pays about a 0.05 percent interest rate. Using our rule of 72, If you divide 72 by 0.05, you will find that it will take 1440 years to double your money. So, if you have $10,000 in your checking account, it’s gonna take you over 1,400 years for that to grow into $20,000. That is a very lousy investment option.
Money Market Accounts
A money market, has a slightly higher interest rate and the average is around a 0.1%. Let’s plug the numbers in our calculation. If you divide 72 by 0.1 percent, it would take 727 years to double your money. Much better than normal saving or checking account, but still very lousy investment option.
Certificate of Deposits (CDs)
A short-term CD might yield about a 1% interest rate and that mean. It means your money will double in 72 years.
If you invested $10,000 as a 20 year old at fixed 1% interest rate, you will be 92 years old when that money becomes $20,000. This interest rate is much better, yet lousy and not big enough.
Yes you could have a long-term CD at that point for better interest rate, so that’s not really a fair analysis. All I’m getting at is that the bank is not the best place to earn compound interest.
2. Stock Market
Second way you can earn compound interest is through the stock market. This is the best way to earn compound interest and that is because the stock market on average pays about 8 to 10 percent per year. It is a compounded return, so using rule of 72 you can see your money doubles every 7.2 years. If you take 72 divided by your 10% return, you can double your money with the stock market about every 7 years.
As a young person you will be able to experience more doubling cycles of your money than somebody who is much older. A 20 year old who starts investing their money is going to experience more doubling cycles than a 50 year old who begins investing their money. This concept right here is also known as time value of compound interest.
Another way that you can earn compound interest through the stock market is through dividend payments. You can either take that dividend payments in cash or you can reinvest that dividend back into the issuing stock. If you reinvest those dividends back into the issuing stock, you’re earning dividends on dividends. Also known as compound interest.
On average, a dividend stock will pay around a 3-6% dividend. AT&T, PPL, F are few companies that pays around 5-7% dividend. Just with that dividend alone you’ll double your money every 12 years by investing those dividends.
Stock Appreciation + Dividend Payments
The great part of this is you can earn compound interest through asset appreciation as well as dividend reinvestment. When you invest in a stock that pays dividends but also has growth potential, you can earn compound interest in two different ways.
For fun, let’s calculate how many years it takes to double your money if you combine dividend payments and stock appreciation.
Earlier, we said stocks on average appreciate around 8-10% per year and earn 3-6% dividends. Add them up and you will get around 11-16% return. Very reasonable number for long term stock investors. Using rule of 72, you can double your money every 4.5 to 6.5 years. However, the most important thing you have to remember here is to take advantage of compound by reinvesting dividend payments.
1. Real Estate:
Third way people earn compound interest is through real estate by investing in real estate. Let’s take a flipper for example. Somebody who buys a house, fixes it up, and then sells that house down the road. On average, flippers earn anywhere from 15-100% return on their money.
Let’s say somebody is able to earn a 20% percent return on their money per year by flipping real estate. Following our rule of 72, they would be able to double their money every 3.6 years. This is how people generate a serious amount of wealth. It is so important to understanding the power of compound interest and understanding how to earn compound interest if you want to become wealthy.
Flippers are only a small portion of real estate investors. There are investors who purchase real estate for cash flow. What does this mean? It means that they will get cash from renters every single month. These investors focus is mainly on how much money they get each month, rather than how much their property value appreciated. These investors get anywhere from 8-15% return on average. If you combine that with 5% percent annual property appreciation, your return is massive. You will be able do double your money in 3.6 years only.
Word of Wisdom
Imagine if you can double $100,000 every 3 years, in just short 16 years you will have 1.6 million dollars. You earn compound interest through your business, through real estate, stock market, dividend payments or you could earn it through your bank account. Bank account is the worst way to earn it.
There are many different ways out there that you can earn compound interest, the main thing you have to understand is that you have to be consistent. If you consistently invest in real estate or stocks, I guarantee you will be successful. Make sure you diversify your portfolio and minimize the risk.
Anyways, that’s gonna wrap up this article. Please drop a comment down below and let me know what is your favorite method of earning compound interest. If you guys have time, make sure you to check out my other post 10 powerful ways to retire in less than 10 years.