Compound interest plays a huge role in wealth-building and passive income. Imagine setting up your life so that you have multiple streams of passive income, which I explain how to do in my article 10 Easy Ways to Earn Passive Income (A Beginner’s Guide). Then, whatever money you have leftover each month after paying your ongoing bills, you invest it to take advantage of compound interest. Over time, your money grows with little to no work from you. It’s in this sense that compound interest acts as an agent—or catalyst—of additional passive income.
What’s great about about setting up passive income and using compound interest is what it does for your life: You can work less, retire earlier (if you wish), have fewer money worries and, more importantly, have more time to enjoy life.
Anyone can use these tools–but, unfortunately, so few do. The wealthy understand compound interest and use modes of passive income; the poor do not. It’s like a big secret that isn’t taught to most of us and by writing this blog post, I’m hoping to change that. By reading through this article, I’m hoping to to give you another tool–a very big one!–that you can use to create the life you want.
COMPOUND INTEREST IN ACTION
In order to take advantage of it, I feel you must understand the basics: In the simplest terms, compound interest is earning interest on interest. For example, let’s say you’ve saved $1,000 and deposited it into an investment account. For simplicity reasons, we’ll say you’re going to earn 10% each year on that money and that you don’t add any more money to that account after your initial 1K deposit. You would earn $100 on interest on that 1K after a year ($1,000 x .10=$100). That would leave you with $1,100 after that first year.
Year two you would earn 10% interest on $1,100—not just 1K—because that’s what you now have. So at the end of the second year, you would earn $110 interest, not just $100, because you started year two with $1,100 (your $1,000 initial investment plus the $100 in interest). So you earned $10 more in interest than the previous year. You now have $1,210.
You would then start earning 10% interest on $1,210 for year three and have $1,331 at the end of year. If you continue to earn the annual rate of 10% for 10 years, you would have $2,593.74 at the conclusion of the decade. Compare this to putting the $1,000 in a an account that doesn’t earn any interest. After ten years, you would still just have 1K.
Now imagine this on a much grander scale: What if you were to save $5,000 a year and add $5,000 each for 20 years. Let’s say you earn 8% per year, which is a reasonable rate to earn in the stock market. At the end of those 20 years, you would have roughly $270,000. Compare this to if you didn’t earn any interest, which would be a total of $100,000. By putting your money into an investment vehicle that returns a strong rate, you’ve “earned” yourself an additional $170,000 without doing any additional work.
LIKE A FINE WINE, COMPOUND INTEREST TAKES TIME
When you start investing has a huge impact on how much money you’ll have in your later years. If you start early enough and invest regularly, you could easily reach millions of dollars by the time you reach your golden years. Conversely, the later you start, the harder it is to attain extraordinary wealth.
Let’s say you decide to invest $250 a month in an account that average an 8% annual return. In one scenario, you start doing this at age 25. In another, it’s age 35 and in a third scenario, age 45. Even though you invested the same amount each month, by age 65, there is a vast difference in the amount of money you would have:
- From age 25= $878,570
- From age 35=$375,073
- From age 45=$148,236
No matter what your age, the time to start is today if you haven’t already. The other point is that you must be consistent in depositing a set amount each month or quarter. Figure out what you can afford to invest and then do it without fail.
If you feel like you don’t have enough money to invest regularly, your spending might be the problem. Check out my articles How to Live Really Well on a Budget and How Selective Spending Increases Your Net Worth to find ways to decrease your expenses.
If the problem is more about not making enough money, then check out my articles 5 Steps to a More Exciting and Lucrative Career and 14 Side Gigs That Pay Well. Better still, if you can increase your income and decrease your expenses, you’ll be on a faster path to financial freedom.
THE REAL VALUE OF PASSIVE INCOME AND COMPOUND INTEREST
Warren Buffet has called compound interest the eight wonder of the world. The true magic of it is how it can give us the gift of more time to enjoy life while still increasing our wealth. People who struggle financially all of their lives may work hard for their money but don’t set up their lives to make their money work hard for them.
I want readers of Blooming Wealth to understand and utilize sources of passive income and the power of compound interest so that each of you can worry less about money and have more time to do the things and be with the people who matter most to you. Understanding and utilizing these two tools is one of the easiest ways to increase your net worth—and it’s one of the primary ways the wealthy get wealthier.
You can use it, too, to change your financial future. Setting up your life with initial forms of passive income and then investing some of that income into accounts that bear interest rates higher than inflation becomes like a money snowball rolling downhill: It grows larger and larger with little to no effort from you.
If you’re not already investing, what’s holding you back? And when it comes to investing, are you getting the best returns? If you’re not sure, you might want to check out my article Why Everyone Should Own Dividend Stocks (A Simple Guide). Personally, I believe that investing in solid companies that pay a dividend above the rate of inflation is the the way to go. This is a great way to take advantage of passive income and compound interest with little risk.
What ways are you using passive income and compound interest to increase your wealth and create more free time? Please email me at email@example.com. I would love to hear what’s working for you!:)