So it was Christmas of 2017 at my parent’s house and per tradition, we had a huge family reunion to celebrate the holiday season together. Now our family get togethers are not your typical ones. It’s not just a small gathering of my immediate family. No in our family, we basically invite our entire extended family over; aunts, uncles, cousins, nieces, and nephews. It has been a family tradition for as long as I can remember.
And because there are so many people over at our house, we typically have to separate everyone into two groups, the adult’s table and the kid’s table. Sometimes I find it funny thinking about the kid’s table because in reality all of us are either in college or have jobs. Some of us are married and some even have kids!
As all the “kids” are eating Christmas dinner, my cousin’s boyfriend speaks up and had the following question:
Hey so I just got a good paying job. I’m making a decent amount of money and I have been thinking about buying a nice sports car.
To which I replied, “Have you thought about retirement?” From there I go on and try to explain the power of compound interest and saving early and how you could have a decent size retirement fund by the age of 65.
After completing my thought, my older cousin said to me and everyone at the table:
Young people don’t think about money and their future like that. You have to say, “Hey do you want to make money with little to no effort or work?” That is what will catch their attention!
So with that, now my question to you is: Do you want to make money with little to no effort or work?
Well I hope your answer is yes, and if so I hope you follow along as I explain to you how you can do it through the power of compound interest!
First Principles
Before we move onto the topic of compound interest and making money with little to no effort, I want to introduce to you all a term that we use in the engineering world called First Principles. The concept of First Principles is basically breaking down complicated ideas down to their basic components or fundamental laws and from there use it as a foundation from which you can build everything else off of.
In today’s world, a famous example of someone using the First Principles way of thinking to change the world as we know it is Elon Musk, the founder of SpaceX and Tesla. He uses First Principles concepts and thinking to look at the cost of sending rockets into space and building electric cars/batteries. Through that he is helping reduce the cost of rocket launches and increasing the availability and viability of electric vehicles.
In an interview with TED Curator, Chris Anderson, Musk is said the following about the First Principles way of thinking:
“Well, I do think there’s a good framework for thinking. It is physics. You know, the sort of first principles reasoning. Generally I think there are — what I mean by that is, boil things down to their fundamental truths and reason up from there, as opposed to reasoning by analogy.”[1]
In another interview he said:
“It is important to view knowledge as sort of semantic tree. Make sure you understand the fundamental principles, i.e. the trunk and big branches, before you get into the leaves/details or there is nothing for them to hang on to.”[2]
With regards to getting rich or becoming financially independent it may all seem very difficult and complicated. The world wants you to think that you need all these fancy financial products and hire some “savvy” financial planner, but that is not necessarily true!
Most of this stuff you can do by yourself with just a little bit of elbow grease and time up front while also breaking things down and applying a First Principles mindset. So with that you may be asking, “How to I break up the idea of becoming rich, or financially independent, or having enough money during retirement with little to no effort? How do I do this so that it is more manageable?”
The first step in applying the First Principles concept to help build the basic building blocks of wealth generation is to understand the power of compound interest. It may seem like a simple concept after I explain it, but I assure you, compound interest is nothing but a powerful tool and is not to be underestimated.
THE MOST POWERFUL FORCE IN THE UNIVERSE
Albert Einstein is said to have called:
“The power of compound interest the most powerful force in the universe.”[3]
Perhaps indeed Einstein may have been right. The power of compound interest has some amazing potential to help you generate wealth as I will explain in the following. So for some of you out there you may be wondering what is compound interest?
Compound interest is in a way like using the “Force” or magic in the financial/money world. It can be a tool for you to grow your money passively (little to no work). In simplest terms, the way compound interest works is by earning interest on your original investment or deposit (principal) and on the accumulated interest from previous periods of investment. So that sounds good and all, but how about seeing this powerful force in action!
For this example let us assume we start off with an initial amount of $1,000. We invest/deposit this money into a bank with an interest rate of 7%. For those who just graduated college and started working, let’s look at how this money grows over the course of 40 years.
Inputting this into a compound interest calculator, we see that our initial deposit/investment of $1,000 turned into almost $15,000 and we did very little to no work! All we did was let the money sit there and make it work for us! Isn’t that just amazing!
Now what’s even more amazing is what if we looked at a case where we were adding more we save to this powerful force what does that money look like. So for our next example we will assume all the same conditions in the previous example, but instead we will add $1,000 onto our initial investment/deposit every year for the next 40 years.
Here is a graphical representation between the two:
Throwing that into our handy dandy calculator our initial investment of $1,000 with the addition of annual contributions of $1,000 becomes roughly $228,600! Isn’t that amazing what saving and investing money will get you through the power of compound interest! Again, all you did here was invest the money into the stock market or a bank and you let the money work for you! You didn’t have to open a business, deal with customers, set up a side hustle, or anything!
Start Saving Now!
For those just entering the work force now, I highly encourage you to embrace the power of compound interest and start saving now. By doing so, you harness the power of time and allow your money to have a longer period to grow. If you don’t believe me, let’s try looking at another example.
In this next example, I will show you that if you invest $1,000 for the first ten years after graduating college and then stopped contributing any more money after that, you would have more money than if you waited ten years and then started contributing $1,000 every year until you hit retirement. For this case let us assume again a 7% rate of interest/rate of growth.
First 10 years:
Last 10 Years:
Before we start looking at the differences between the two cases, I just wanted to first point out and reiterate the power of compound interest and how you can let your money work for you! In either case you either made roughly ~$180k or ~$150k when retiring at the age of 67.
Looking at both cases you can clearly see that if you started saving early and stopped after ten years of saving and investing $1000, you still would end up with more than $32k than if you started at the age of 32 and invested $1000 every year until the age of retirement. Isn’t that absolutely crazy!
Conclusion:
Hopefully by now after looking over all the math and numbers, you are convinced that compound interest is the most powerful force in the universe! I hope through the above you have learned to have a better appreciation for saving and investing for the long term and to help use this new found power to help you save for your bright and wondrous future!
Further, I also hope that you enjoyed the first of money in this series called “First Principles”. I not only look forward to breaking things down for you, but I would also like to get your input, advice, and comments.
What do you think? What have you done so far in your journey to save for retirement, financial independence, or just to create wealth?
Below the Fold:
I have titled this section as “Below the fold” to serve as a place to help further explain topics more in depth and look at the math for those of you who are interested in compound interest and etc. I know personal finance can be boring and dry so I will try my best to present these fundamental concepts in a fun and engaging manner in the main body of the post. All that dry stuff will be here, should you want to investigate these topics further.
- For those who want to learn more about compound interest here are some really good links!
https://www.investopedia.com/terms/c/compoundinterest.asp
https://www.fool.com/knowledge-center/compound-interest.aspx
- Compound Interest Calculator you can play with to help you see the “most powerful force in the universe” in action!
http://www.moneychimp.com/calculator/compound_interest_calculator.htm
Sources
[1] Musk, E. (2013, February). Elon Musk: The mind behind Tesla, SpaceX, SolarCity… Retrieved 4 June, 2018, from TED: https://www.ted.com/talks/elon_musk_the_mind_behind_tesla_spacex_solarcity/transcript
You can watch the whole TED talk here:
https://www.youtube.com/watch?v=Mdm5JsOUQpQ
[2] Musk, E. (2015, January 6). I am Elon Musk, CEO/CTO of a rocket company, AMA! Retrieved June 4, 2018, from reddit.com: https://www.reddit.com/r/IAmA/comments/2rgsan/i_am_elon_musk_ceocto_of_a_rocket_company_ama/
[3] Einstein, A. (2018, June 4). Albert Einstein Quotes. Retrieved from Thinkexist.com: http://thinkexist.com/quotation/the_most_powerful_force_in_the_universe_is/158830.html