As soon as you start reading about creating wealth and money saving tips you will stumble upon the topic of Compound Interest. It´s everywhere!! Dozens of famous books have been published about this magical money making tool. Thousands of gurus claim that this is the ultimate key to wealth.
But reading more about this topic I found one fact to be true: Compound Interest works…. but it will NOT make you rich!
Compound Interest is great if you already are rich. Starting with five million dollars and seven percent annual return will make you 350.000 dollar the first year. But you already need the five million dollars to begin with.
The problem with Compound Interest is that it takes a loooong time to work in your favor. And since you only have about 80 years to figure it all out, Compound Interest is really not as effective for creating wealth, unless you are Wolverine and therefore immortal.
For everyone who is not immortal the common advice is to save a few dollars every week on coffee, gas or something else, so you can retire rich. But is a lifetime of poverty really worth the three years of riches you´ll gain?
(And remember that you will only get rich if there is not another stock crash or basically no raise in prices during the next 60 years!)
The only ones profiting from Compound Interests during their lifetimes are those who provide the indexed funds, mutual funds and 401(K)s you are putting your money into. So, if you are one of those people, go ahead and tell everyone you meet about the great benefits of Compound Interest! You can also stop reading at this point.
I don´t know about you, but I don´t want to retire at 67. I want to retire during my thirties or early forties. Therefore, Compound Interest is not my primary tool to achieve that goal.
I also don´t want to save every penny I make, never going out with friends, never traveling the world, never buying an expensive present, never eating expensive steak. Plus, I´m not a patient person. I don´t want to wait for 60 years for the magic of Compound Interest to kick in.
I do not doubt that the stories about people who found success with Compound Interest are real. They certainly are. The math shows that it IS possible to get rich that way.
But for every person who retires at 53 with a million dollars in their bank account, there are ten thousands of people who have to work past the retiring age just to make ends meet. It´s just that the media blows up every single success story, making it look like Compound Interest is great for accumulating wealth.
Compound Interest looks great on paper and bad in reality.
If you are 20 years old today and start saving 5.200 dollars a year (or 100 dollars a week) with a seven percent interest, you will have 2.192.416 dollar in 50 years. But only if you are able to save that much money all that time for 50 years, only if you are getting at least seven percent interest for 50 years, and only if the stock market never crashes during those 50 years.
And this won´t even take inflation into consideration. Two million dollars today can buy you a lot more than two million dollars in 50 years.
What is the solution to that problem? How can YOU make Compound Interest work for you?
Think BIG! Don´t try to save 5.200 dollars a year. Don´t try to save 20.000 dollars a year. Save 100.000 dollars a year!
100.000 dollars a year with five percent interest (much more doable than seven percent) are 3.531.723 dollars in twenty years.
So the solution is to make more money instead of just trying to save a few dollars here and there.
And as long as you can´t save 100.000 dollars a year you should not bother caring about Compound Interest. You should be caring about making more money.