WTF is Compound Interest?

You know how rich people always tell you to “make your money work for you?”

Have you ever wondered what the hell they mean? Well, they are most likely talking about compound interest and investing—how Warren Buffet, the greatest investor ever, completely self-made, created his 85+ billion net worth. (In fact, it’d be much more if he wasn’t also one of the greatest philanthropists ever, having donated the most money at 30+ billion dollars in his career.)

Let’s pretend you have just $10. (Shout out to my fellow college students who don’t need to pretend!)

Now, if you had that $10 in a bill form, or you had it in a bank account, it’ll always just be $10. No matter how hard you wish, that $10 bill will always be a $10 bill. Unfortunately so…

BUT! What if you made your money work for you? How does that work?

Well. Actually, you give that $10 to someone else–someone who will use that money to create a business or product, or service and generate wealth. This is a very basic principle of investing.

In the early days, Apple needed money to do research and develop their products. In the early stages of many great companies, they needed capital that they received from investors. In return, those investors received stock & equity, or % ownership of that company. Now, when that company starts to generate large amounts of profit, the owners are the ones who benefit. (So really, your money isn’t working for you, you are just giving it to someone else to work for you)

Okay, but that doesn’t explain what compound interest is. I am getting there.

Now, compound interest is just a fancy way of saying the more of something you have, the more you can create over time. The more money you have, the more money you can make over time. One very important concept is that this takes time.

Pretend each $1 you had was a worker. So, your $10 bill can become 10 workers if you invest it.

Every year, each 1 worker will make 10 cents for you. That means, after 1 year, your 10 workers created a whole $1!

Year two, you don’t have 10 workers anymore. You have 11!

Year three, you have 12.1 workers! (Let’s pretend that this is a world where you can have a fraction of a person…)

by year 10, you suddenly have a factory of 26 workers. Crazy, right! You went from adding $1 a year, to now adding $2.6 a year.

Every year that passes, you get more workers. Quite literally, you are making your money work for you in this scenario.  You live in a strange world where your factory workers aren’t creating any product, but they are essentially creating more workers… The more workers you have, the more workers you create. The more time you have, the more time your workers have to work, the more workers you create. It’s kind of creepy, actually. But don’t forget, workers=money in this scenario, so this is a great thing!

Compound interest is great that way. You create wealth simply by using time. After all, time = money.

In the stock market, when you receive returns, or interest % gains, they accumulate on top of each other. Compound interest essentially means “interest on interest.” And, because interest is money, you are getting “bills on bills.”

But WAIT. It get’s even better. No one ever said you couldn’t add more workers to your factory. In our scenario, we added $10 at the start only, without adding more at any other period, and ended up with $26 after 10 years. But remember, the more money you have, the more money you make. So, if you put more of your money to work, you’ll end up with more at the end. This is why a general guiding principle is to aim to invest at least 10% of your income every year, ideally 15-20%. You are adding more fuel to the factory by pumping more workers. It’s pretty simple when you think about it. And if you do manage to invest at least 10% every year, you can retire a multi-millionaire.

Time is the most important thing about compound interest because the more years you are able to compound your money, the more money you can create. Investing for the future is a long-term plan. In fact, Warren Buffet created 99% of his 85+ billion dollar net worth after his 50th birthday. He wasn’t even a billionaire until his mid-50’s!

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So that’s compound interest in a nutshell. That’s how you make your money work for you. And, as I said, time is the most valuable asset you have to take advantage of compound interest. So what are you waiting for? Invest now!

Here is the compound interest calculator I use: Moneychimp Calculator


Ready to take advantage of compound interest? Check out these articles:

  1. Why should I invest
  2. How the F do I start Investing?

Other DTF Articles:

If you have more questions, please feel free to reach out. I will gladly help you with any concerns, and we can hop on a call/chat if you want.

Email me: downtofinanceDTF@gmail.com

Follow me on social media! Instagram: @DowntoFinance


Disclaimer:

I am not a professional financial advisor or planner as much as I’d like to be. All thoughts on the DTF Website are strictly my opinions unless otherwise stated. I understand there may be errors in my writing. My articles are not meant to be offered as professional advice, as I am currently learning a lot about finance myself. Please always do your own research and due diligence when it comes to financial decisions. Money is very important! I may own some stocks discussed in this article.

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