Failing To Use Compound Interest: The Number 1 Financial Regret
Did you know that 56% of Americans claim that their biggest regret in life is not saving enough money?
What makes it worse is that 76% of Americans have financial regret overall.
In the UK it’s no better. The Independent reported in May 2018 that Brits need at least £260,000 to retire without money worries.
The situation is particularly bad for millennials. Supposedly four out of ten have no pension provision, according to YouGov.
So, people have less money for retirement, retirement is getting more expensive, and fewer people are thinking about saving for it.
What can you do?
Well, there are many other ways you can save money. One of those ways is with compound interest.
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First off, what exactly is interest?
Interest is what is earned on top of an amount of money when it is borrowed.
For example, if you borrow money from your bank or credit card, you will need to pay it back plus a percentage.
That percentage is the interest they receive or the interest you receive if someone borrows from you.
Interest can be a great way to enlarge your savings but unfortunately, in most cases, it can fall victim to inflation and cannot keep up with the rising costs of living (more on that in a bit).
Don't miss: Why Is Investing So Much Better Than Saving?
What is compound interest?
Think of compound interest as an improved version of interest.
The concept of compound interest was supposedly described as “the greatest mathematical discovery of all time” by none other than Albert Einstein.
But you don't need to be a mathematical genius to understand it; in fact, the concept is fairly simple.
When you invest money, you earn a rate of interest on your capital. A year later, you earn interest on your original capital plus the interest from the first year.
It is basically interest on your interest.
This cumulative effect keeps building up year upon year, and this is the miracle of compounding.
If you don't take advantage of this fantastic phenomenon from the earliest possible opportunity, it will be at the top of your financial regrets further down the line.
Who invented compound interest? A quick history
The exact origins of compound interest are uncertain, though it is known that it has been in existence since at least Roman times.
In fact, it was actually banned because it was believed to be a tool for lenders to extort large amounts of money from borrowers.
Compound interest came to the publics’ attention after it was explained in Francesco Balducci Pegolotti’s Pratica della mercatura (Practice of Commerce), which was published in 1340.
The most important rules of successful compounding
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The earlier you begin, the more likely you are to gain from your investments with relatively little input. Time is an important factor because interest increases with it.
In fact, consistently investing relatively small amounts over time can yield astonishing results.
For example, if you invest £100 a month for 40 years, with a compound of 12% per year, at the end you will have a mindblowing £980,000!
While this sum is staggering, you shouldn’t come into an investment with the mentality that it’s easy money.
Play the long game and put in the effort. That’s how fortunes are made, not with blind optimism and hopes that things will all turn out fine in the end.
Instead, get an education on all things finance and rule the world of your personal wealth.
The power of compounding
The world economy is set up in such a way as to encourage investment and the flow of money. After all, what good is wealth if it merely stands in one place?
Proactivity and investment are rewarded, not saving up and hoarding money. We now have to generate wealth, not just keep it locked away.
If that wasn’t the case, the world’s finances would be quite stagnant. People wouldn’t spend their money and that money couldn’t be invested into new endeavours.
That’s not to say that everyone should just start spending their entire income, merely that multiplying your money is a better idea than keeping it static.
When you think about the effects of inflation, it becomes apparent that staying at the same spot is actually going backwards.
Imagine it like walking the wrong way up an escalator. If you stop climbing, the steps move downwards, taking you with them. You don’t want this to happen with your finances.
In that metaphor, the steps are the economy. It always moves in such a way as to inflate the value of your money or drive up your demands.
Think of rent, the prices of fuel, or even how much you had to spend for lunch just 10 years ago. Chances are that the amount of money you spent was less than what you have to spend now.
On the flipside, your salary probably increased, with employers and the government bragging that they have “increased your salary” while not mentioning the fact the value of that money has probably decreased.
In fact, many people have a who have a decent salary end up not moving forward in life. This is because these people do not understand basic facts about the economy and investment.
Staying in the same spot is going backwards
Staying at the same spot requires walking forward but thriving will require running. The main mistake people do is decide that what they do have is enough and then they stop developing.
As mentioned above, this does not work because things change constantly. Staying in the same spot is going backwards.
That’s the Number 1 financial regret traders and regular people have in the end.
To get the very best out of compound interest, you must be aware that seemingly small differences in return actually make a huge impact, so don't shrug off a difference of 1%.
Compounding offers great returns, particularly when you start early. Understand that time and patience are fundamental to compounding.
Don't squander your inheritance all in one go; this is one of the classic financial mistakes. You need to find the right balance between enjoying yourself now and providing for yourself later.
Patience is an important factor of a good investment.
You don't want to be preoccupied with your finances in your old age, and the only way to be able to relax fully after retirement is to have made the appropriate arrangements beforehand.
You should focus on acquiring some quality assets from a young age as an adult, learn how to manage your capital efficiently and not waste it on liabilities that will only depreciate over time.
Compounding is most profitable the earlier you start doing it, so act now to get the most out of your investments.
Your life doesn’t end with retirement, but it also doesn’t begin there. You have to think of your future prior to it happening.
If you don’t, you run the risk of an unpleasant surprise once you do reach your “Golden Years”.
The two most important factors of compound interest
Those are the percentage of interest received and the compounding frequency (compounding periods).
The more compounding periods you have the better. Each one presents an opportunity to grow faster and larger.
For example, if something is compounded every week (which is quite regular!) it will earn you a lot more than if it was compounded every month or year.
Alternative to compound interest: Trading
As expert educators in trading, we can’t avoid telling you about the benefits of trading. Sure, compound interest can be hugely beneficial when you’re old, but trading is also another option.
While it is hard to say exactly how much a trader can make, it is a great option for those who are able to set manageable goals.
You will not win trades all the time, but as long as you are consistent in your approach to trading and appropriately analyse your risks, it is possible to make significant gains.
Day trading, in particular, can be a great way to compound your income in a short period of time.
Forming relationships with other traders, even beginner ones, is important for your future forex trading developments. A good income starts with good knowledge, so spread it around.
Check out more of our articles for more on trading.
If you remember anything from this article, make it these key points
- Compound interest is great if you're earning it and bad if you're paying it. Make sure you're on the receiving end.
- The more compounding periods the better. Each compounding period adds more interest to your interest.
- Utilising compound interest is the best way to be prepared for retirement. If you start early, it can rise to a significant amount over 40 or so years.
- Trading is a good alternative to saving. By learning how to trade financial instruments like forex, savers can put away a good deal of money for retirement.
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