Have you ever wondered why so many people are obsessed with making money from the stock market or other similar investments? It’s because of the investor treasure known as negative compound interest.
If you want to obtain this treasure, you must learn about the power of constantly compounding interest, or compounding income.
Compound income and compound interest can make your money grow beyond any amount you could ever hope to achieve on your own. Here’s how.
The marvel of compound interest and its brainchild, compounding income
Albert Einstein was credited with the connection Compound interest “The greatest mathematical discovery of all time.” And he’s absolutely right when it comes to practical applications; Especially when it comes to your money.
Compound interest is a phenomenon that occurs when your investment profits combine with your original investment (called principal) to create larger and larger profits over time.
As you will see in the example below, earnings growth eventually becomes so large that it exceeds the original principal contributions and begins to explode at an extraordinary rate.
That’s why successful investors say that getting the first $100,000 from an investment is the hardest. After you save and earn interest to accumulate your first $100,000, compound interest makes your money grow much faster.
What does this mean for you? Double income (i.e. more money) – with little or no work on your part.
Compound interest: the eighth wonder of the world
Compound interest is a financial benefit that you definitely want in your passive income portfolio. In fact, Albert Einstein called it the eighth wonder of the world.
Compound interest income provides a very unique opportunity for you because once your portfolio reaches a certain threshold, you can theoretically live off the residual income your money earns each year – indefinitely.
Unlike some other strategies for building passive income, living off your investment earnings can be a 100% passive process if you choose to use a quality investment like a stock market index fund.
Two options – which one makes more money?
To illustrate the benefits of compound interest, let me start by asking you a question. How much would you make if you invested $10,000 a year for 40 years using one of two investment options:
a) Under your bed?
b) In a stock market index fund?
Result:
The second option yields about 6.5 times more money than the first? Why is this? That’s the beauty of ever-increasing interest over time.
It can lead to the potential for ridiculously more money over longer and longer periods of time.
A closer look at how compound interest works consistently:
So, to understand how we were able to get this higher number by harnessing the power of compound interest, let’s break down this process a little to see how it works and benefits our efforts at getting rich.
Option A is easy to understand. You simply take $10,000 each year and literally put it under your mattress (just like they used to do during the Great Depression).
Because your investment earns Absolutely no interest (Since your salary is not the same as the bank’s and they don’t pay you interest), the calculations for this scenario are very easy to understand:
- $10,000 x 40 years = $400,000
Although this is mathematically what you’ll get, the reality is that your money will be worth less than that. This is due to losses caused by inflation during that time.
In fact, using the rule of 72 and an inflation rate of 3%, your money will be worth half its value after 72/3 = 24 years. So, in about 40 years, the money you chose to keep “safe” by stuffing it under the mattress will be worth about a quarter of the purchasing power it has today! Yes!
This is a huge hit to your wallet!
Option B is best understood using an explanatory process.
For simplicity in this example, let’s assume that your investment earns a fixed return of 8% each year. (This of course never happens in reality, but it will help explain how compound interest works in this lesson.)
also, The average return on the Standard & Poor’s 500 Index From 1957 to 2018 it is actually 8%. Okay, on to the example.
To start at the end of year one, we invest $10,000 and earn no interest.
At the end of year two, we invest another $10,000 for a total of $20,000. The 8% return on our $10,000 is $800 (in red), thus placing it above our principal investment (in blue).
Now continue this process for another 3 years and we reach the end of the fifth year. We invested $50,000 (5 x $10,000) and our ROI rose to $8,666 ($800 + $2,464 + $5,061).
Notice how as our total portfolio amount increases, our return on that investment also increases.
Now fast forward to the end of twenty years. Now how much money we earn from our total investment (in red) It actually starts to exceed the total amount of money we initially invested each year (in blue).
By the end of year 40, the continued power of compound interest had resulted in returns actually contributing to the overall portfolio beyond what we originally put into it.
amazing! This is amazing, don’t you agree?
So how does this lead to great passive income?
How does a nearly $2.6 million portfolio help you financially? How about letting you live passively on just over $100,000 each year?
Most people can easily live on $100,000 a year, and I might add, they make a pretty good living.
If you follow the traditional financial planning suggestion to use… The withdrawal rule is 4 percent For retirement, you could allow yourself to withdraw 4% from your portfolio each year (and then adjust for inflation each year after that).
$100k per year in passive income is no small accomplishment!
Contrary to this point, how much money can you withdraw each year using the “under the mattress” saving technique? 16 thousand dollars every year – a number that qualifies you for poverty. Which option would you have chosen?
Smart investors always take advantage of compound interest
Every successful investor, from Warren Buffett to Peter Lynch to John Bogle, relies heavily on the power of compound interest.
The successful investor knows that this type of passive interest earning is the key to maximizing wealth growth.
That’s why smart financial planners always recommend starting retirement savings early and investing as much as you can.
How you invest is also important
Note that it is important how You are investing. Almost all investing involves some level of risk. However, successful investors do not take Unnecessary risks.
For example, it is common for smart investors to invest in blue-chip stocks that produce dividends. Blue chips are stocks in tried-and-true companies with a long track record of success and sustainability.
Think Coca Cola, 3M, Walmart, Johnson & Johnson, McDonald’s, etc. It’s not like these companies can’t lose money.
But they have proven over time that they have strong staying power.
While smart investors choose investments that gain slowly and steadily over time, they stay away from riskier investment options like day trading, where very few investors make money.
The percentage of investors who make good money through riskier options like day trading is incredibly small compared to those looking for smaller but more consistent returns.
Do your own research
As someone looking to generate passive income through investing, it is very important to educate yourself. Read books from experts like John C. Bogle who share investing tips and secrets.
Use their successes – and failures – to gain more information to help you make investment decisions that are right for you.
The better your investments perform, the more compound interest you will earn.
Here are some ideas to consider if you’re looking to grow your money faster through compound interest.
*Note that all investments listed here – and all investments in general – have the potential to lose money.
1. Invest in stocks that pay dividends
Dividend-paying stocks are stocks that pay you money simply for holding shares of the stock. Every quarter or so (depending on the stock) you will receive a small percentage of the value of your shares as a type of cash bonus.
Some people take this cash “bonus” as a source of passive income to help them pay the bills. In fact, if you have a large enough amount of money invested, you can likely live off your dividend income.
However, if you don’t need the income, it’s wise to choose to reinvest your dividend payments so you can help your stock shares earn more compound interest.
Reinvesting your dividends will help your portfolio balance grow faster.
2. Invest in peer-to-peer lending
Peer-to-peer lending is when you lend money to borrowers, and the borrowers pay you the interest on the loan instead of paying the interest they pay to the banks.
Lending Club is an example of a company that provides peer-to-peer lending to investors. As an investor, you are shown a list of loans requested by potential borrowers.
You can see all the loan factors, such as the amount they are asking for, the interest rate, the loan term and grade. The score reflects the credit standing of the borrower.
Then you choose the loans you want to finance, and the loan amount you want to finance.
When the loan is repaid, it is paid back to you with interest. You can reinvest this money to earn more interest.
It is truly a revolutionary way to invest your money. Why let the banks have all the fun when you can take some of the profits for yourself?
3. Invest in real estate (at a reasonable cost)
Traditional real estate investing can be profitable, but it’s also expensive. However, there are many companies that offer crowdfunded real estate investment options.
In other words, they purchase real estate investment properties (commercial and residential properties) with money from a group of investors. When investments generate profits, investors get a portion of those profits.
As with other types of investments, you can take your profits in cash, or reinvest them in your fund, depending on the investment company’s model.
For example, companies like Fundraising Investing in commercial and residential real estate. They do this using crowdfunding money from investors like you and me.
The profits are then split with the investors. You can invest with Fundrise for as little as $500, making it affordable for almost everyone.
As you can see, there are many options for earning more compound interest on your investments.
4. Invest in a mutual fund with a good track record
Some investors simply invest in Stock or bond mutual funds have great performance records. One such popular fund is the Vanguard Total Stock Market Index Fund (VTSAX).
Created in 1992, this fund has an average return over ten years of more than 10%. The fees are also low, which is another reason why it is a favorite among investors.
The mutual fund you choose to invest in depends on your risk tolerance level and other factors. Look for popular investment books such as The Intelligent Investor by Benjamin Graham For more in-depth investment advice.
While good mutual funds usually provide consistent positive returns over time, it is possible – just as with any investment – to lose money when investing in mutual funds.
That’s why researching and choosing the right mutual fund investment is so important.
summary
The powerful results of consistent interest and compound returns can help you grow your investment portfolio much more than you would have been able to without it.
An essential part of discovering the best sources of passive income for yourself is to seriously consider the power of compound interest. I personally use it as the primary source of my passive income portfolio.
My crowdfunded real estate account with Wealthy uncles It is one of the best performing passive income accounts. And compound interest (since I’m currently reinvesting my dividends) is a big part of the performance success.
Take advantage of compound interest for your passive income portfolio. Use it to create a lot of money to live off of passively.
Do you use the benefit of compound interest to grow your personal wealth?