Albert Einstein was wrong … the financial experts are wrong … and, we’re about to debunk perhaps the greatest – and, most misleading – of all finanical ‘truisms’ …
… and, you’ll be able to say that you read it here first 😉
You see, the cornerstone of almost all personal finance books and philosophies is the so-called ‘Power of Compounding Interest’ … if you need a primer, check out this little video that I ran last Sunday: http://www.youtube.com/watch?v=qEB6y4DklNY
There is no disputing that compounding interest has immense power, but only when compared to so-called simple (or ‘flat’) interest; use the Rule of 72 (that Albert is writing on the blackboard) to see for yourself: simply divide any old interest rate into 72 to see how many years it will take to double your money …
… for example, at 10% interest, you would double your money in just over 7 years.
Neat, but useless …
You see, Luis gently reminded me of this blog’s “motto”:
Now, find out how you can make $7 million in 7 years … no scams, no schemes … just good old financial advice!
As Luis pointed out, we aren’t trying to double our money in 7 years … we’re trying to make $7 million in 7 years!
Unless you’ve already got $3.5 million in the bank, you simply won’t get there … and, if you do have $3.5 million in the bank, you’re not reading this blog, you’re reading the one about “How to get to $170 million in 7 years” 😉
You see, in order to work, compounding interest needs a key ingredient … one that we don’t have much of:
In order to produce a large outcome (say $7 million) – starting from a small base (say $50,000) – compounding needs BOTH a high compound growth rate and a lot of time.
For example, if you start a business that has the potential to deliver an annual compound growth rate of 50%, you still need to wait 13 years before you reach the magical $7 million.
If you choose a more ‘mundane’ investment, such as managed funds that might deliver a 9% return (after fees), you could wait 38 years and still barely crack your first million.
And, if you manage to save 30% of your salary (say, $50k starting salary, growing 3% per year) and invest it in those same managed funds, you should manage to crack the $1 million mark in ‘just’ 21 years, and you will be well on-track to write your own blog: “How I enslaved my way to $7 million in just 40 years”.
Compound interest isn’t a ‘force’, it’s an effect that occurs when you simply sit back and don’t do anything!
Do you think you should be handsomely rewarded for that? Do you seriously think that sitting on your hands will propel you into the top 1% of Net Worth in, say, the USA?
Or, is your goal simply to save your way to the biggest Number that you can achieve before you are retired? If so, compounding is an effect that you should study very closely.
But, this is a blog about how to get Rich(er) Quick(er); it’s for those with Large Numbers / Soon Dates …
… to us, compounding interest is slavery … if this is your prime investing strategy you enslave yourself to a life of work and frugal living, running the risk that being able to truly live your Life’s Purpose will remain just a dream.