More than anyone else, Albert Einstein has contributed the greatest insights into our understanding of time. Admittedly, much of his work was in the field of theoretical physics, yet he also had the ability to explain financial concepts in a manner that most people would understand. In the area of personal finance, he opined that “Compound interest is the eighth wonder of the world. He who understands it, earns it … he who doesn’t … pays it.”
Compound interest is merely earning interest on the interest you have already been paid. Investors who reinvest dividends and interest into their mutual funds are earning compound interest. Consumers who pay the minimum charge on their credit cards are paying compound interest. Anyone who has made minimum payments on their credit card for any period of time can attest to the power of compounding, to your disadvantage.
Obviously, the more time we have to compound, the greater the potential benefits. Unfortunately, our desire for instant gratification can conspire to defeat the benefits of compounding. Just knowing how compound interest works can not only change your outlook on life, but can contribute materially to your quest for financial independence.
Stop and think for a moment: are you doing anything to take advantage of Einstein’s Eighth Wonder of the World? If you have contributed to a retirement account, you are using compounding to your advantage. If you are not regularly contributing to a retirement account, you may be letting instant gratification get the better of you. If you are taking loans from your retirement account, that tends to rob you of the benefits of compounding.
Wealth accumulation is often the result of deliberate actions that allow compound interest to work silently in the background. Understanding its power can be a game changer for you.