Albert Einstein said: “Compound interest is the eighth wonder of the world. He who understands it earns it … he who doesn’t …pays it.”
Compounding is one of the most overlooked and yet powerful tools to create wealth.
What is compounding?
The definition of compounding is the process whereby interest is credited to an existing principal amount as well as to interest already paid. Compounding can thus be construed as interest on interest, the effect of which is to magnify returns to interest over time.
Two ways to create wealth through compounding: Accelerate asset value and accelerate debt reduction.
Compounding Asset Value
For example, with an initial investment of $100,000 at an interest rate of 8% compounded monthly over 15 years with no additional investment, you will generate a total capital account of $330,690.
Better yet, if you were able to contribute an additional $15,000 per year to your investment over the same 15 year period, your investment account would total $766,000. It is incredible how fast your investment will grow by letting your money compound.
Compounding Debt Reduction
The miracle of compounding also applies to reduce debt, which indirectly increases your net worth.
When you think of compounding, most people think of compound interest, but it also goes in reverse when you accelerate payments on a loan; you are able to take advantage of the miracle of compounding by decreasing debt at an accelerated rate.
For example, if a borrower had a $1,000,000 loan amortized over 25 years at a rate of 6% with a P&I monthly payment of $6,433 made two payments monthly instead of one, the loan would be paid off in a little more than 12 years with a savings of over $523,000 in interest expense.
Accelerating loan payments drastically reduces the amount of interest paid over the life of the loan and, at the same time, increases the borrower’s net worth.
The rate at which compound interest accrues depends on the frequency of compounding; the higher the number of compounding periods, the greater the compounding effect.
So, whether you are investing money or paying down debt, you can take advantage of the miracle of compounding.
Compounding Effect Goes Beyond Just Money
The compounding concept not only applies to money but all aspects of life, i.e., our habits, health, relationships, knowledge, etc.
The seeds of greatness are planted in the daily grind. In his book Good to Great, Jim Collins explains that in the transition from good to great, the flywheel starts slowly, and through consistent, small actions, momentum builds. Slow but consistent gains add up much faster than you can imagine. Small, positive changes add up to massive improvements over time.
Compounding is a long-term strategy and requires patience when investing and discipline when paying down debt.
Reminder, accredited investors can take advantage of the miracle of compounding with an investment in Fidelis Private Fund. www.fidelispf.com.
Fidelis is currently generating an 8% annualized return to our investors, which means without any further investments, you can double your money in less than nine years when you let it compound monthly.
If you are more interested in how compounding can benefit you I suggest you read “The Joys of Compounding” by Gautam Baid. This book was recommended to me by my friend Pat Geary who shares the same desire to learn and grow on this journey of life.