Understanding Compound Interest And Why You Need It Working For You
Compound Interest is the juiciest wealth generating mechanism around.
Getting it working for you is Wealth Rule # 1.
Compounding truly is one of the most important principles that you need to get working for you to have generative growth, success, financial abundance and expansion in this vital area of your life called money.
Have I made it clear yet?
You have to have compounding working for you!
Sadly, this amazing thing is also one of the most misunderstood, the most abused and the most confused wealth concept around, which is why I did this video for you, so hit the play button to discover why it is so damn fantastic.
What are we talking about when we're talking about compounding?
In relation to your financial wellbeing, compounding is where you take a little bit of money and you invest it, you get it working for you in the form of an asset - stocks and shares, investment property, or even low input business’s - something that can earn income or grow in value.
That growth then gets to work for you, and it then earns you more money and grows in value. Where there was 2, now there is 4, and then there is 8.
With compounding there is an exponential principle that accelerates your wealth and shortens your time to freedom because assets are working for you and creating your wealth.
****WARNING*****
Compounding has no value judgement,
it works for whoever understands it best.
Compounding doesn’t go “Ooh this is a good person or that's a bad person, so who should I or shouldn't I work for?”
Most people don’t understand the power of compounding and allow it to work against them, in the form of consumer debt.
This is where you pay for something on a credit card or an overdraft, or loan and interest gets charged on the amount owed. There is the initial sum owed. Interest is added to that capital amount, and then that interest gets interest charges on it, and before you know it, compounding has snowballed the amount owed and it’s taken you into ‘money-hell’ rather than ‘money-heaven’.
That interest is compounding working for the person you owe and against you. Your consumer debt is their asset.
So that's the principle of compounding. it can work for you and get you to your freedom faster by growing your wealth, or it can take you rapidly to poverty and desperation by working against you if you have consumer debt.
So we’re clear that you need compounding working for you to create your financial freedom.
We can understand this intellectually, but one of the things most of us mere mortal humans find hard to do, is think in an exponential way.
We think in linear ways... 1+1=
But it's really hard for us to think exponentially, which is how compounding works.
A great example to understand the exponential nature of compounding is this:
If I offered you…
- One million dollars now, or
- One cent today and every day for a month, I will double it so tomorrow I'll give you two cents, day three I'll give you four cents, and so on for 30 days
Which would you choose?
Would you want the one million dollars now, or would you want the one cent doubling every day?
Most people will choose the million dollars. I was at an event speaking to over 4000 people and I asked them the same question, and as expected, 90% of the room said “Give me that one million dollars today”.
This is one of the biggest behavioural challenges people have on their wealth journey.
People tend to have a bias towards perceived short-term gain plus they don't understand the power of compounding.
These two factors result in more wealth destroying decisions and behaviours than any others.
If you understand compounding you would know that at the end of 30 days, if you had chosen the option of one cent doubling each day, you would end up with over four million dollars!
That's the power of compounding!
Let's unpack the four elements that make compounding work and the principles you need in place to make it work for you.
#1: Compounding Needs Consistency
If you invest a lump sum in an Index Tracker, or into some other kind of investment and let it grow, compounding will work for you, but when you set up a regular investment, this really supports the acceleration of compounding.
Compounding needs consistency of contribution and it thrives with consistency of strategy.
Most people start something, then before long they get bored and start to fiddle, then they tweak it and change their approach. With every poke, adjustment, fiddle and tweak, compounding gets set back. It can’t get traction and the power of compounding never gets a chance to do its magic.
I'm not saying you never adjust your strategy. But you need to give any strategy time to get settled and start working.
This works hand in hand with the second element compounding needs.
#2: Compounding Needs Time
Time to allow the strategy to get legs.
Time to allow compounding to start working.
Time to allow the first iteration or the first investment growth to work.
“Time is a key element compounding needs to give you exponential growth. The more time you can give it, the more you’ll get.”
#3: Compounding Needs Reinvesting Investment Returns.
So many people rob themselves and prevent compounding working for them by feeding off their investments too soon.
They consume the rental income from their property investments, they spend their dividends from their share investments, instead of letting this third element work for them.
Compounding needs you to reinvest those investment returns. You must allow the asset generated / investment income to be reinvested, so it can work for you and build the wealth snowball. Only when your investments have grown to a sustainable size do you start feeding of them.
#4: Compounding Needs You to Go Away, Live Your life and Leave It Alone.
Compounding is a lot like yeast. When you bake bread you activate the yeast by a set of actions.
The same happens with compounding for your wealth. You activate it by investing in or creating an asset to work for you.
Once the yeast is activated, you leave it to do its thing (to prove), and the bread starts expanding. It then goes into the oven and is given time to expand and grow. If you fiddle by opening the oven, or you poke the dough while it is proving - you will mess up the yeasts’ action and effectiveness.
This is the most important principle to allow compounding to work its magic in your life.
Go away, leave it alone, live your life and let compounding do its work.
Most people fiddle with their investments, make inconsistent contributions, rob their investment return and don’t give their strategy time to work.
Change those four things, and you’ll have this amazing thing called compounding working hard for you.
It’s not only in the financial realm of our lives where compounding can help us...
When you think about it, compounding works in every aspect of our lives.
Relationships, health, fitness, business, joy, skills.
Compounding works in every one of these areas because that is what compounding does.
Compounding works on energy created by action.
That's all money really is.
“Money is an energy created by a value exchange”
When you can apply compounding in each of these other areas of life, they will expand too.
In each area you can ask yourself these questions:
In business:
- What do I need to be more consistent with?
- Am I compounding on actions?
- Am I compounding my learning?
- Am I giving space and time for a strategy to work?
- Or am I leaping around all over the place?
In relationship:
- Am I being consistent with connection and engagement?
- Am I investing time, energy, money into my relationships?
- Am I reinvesting my returns in these relationships?
In fitness and health:
- Do I jump from one fad scheme to another?
- Do I allow a healthy eating regime or workout regime to gain traction and give it time to work its magic?
- Am I consistent with the actions I take?
- Are you robbing yourself by taking too much energy from your system and not allowing compounding to refill your taks?
Compounding can also work against you in these other areas.
- Where in your life is there a compounding negative spiral?
- Where do you have the equivalent of consumer debt in other life areas?
- Are you compounding the negative in life by focusing on the things that aren't working?
That is the end of this mini masterclass on the juiciest concept around - compound interest!
We have created a cool COMPOUND CALCULATOR for you to play with to see for yourself the impact of different rates of return (interest rate), ongoing contributions from you and of course time.
Use this to plan your time to freedom, see what you need to be investing to reach your Freedom Number; to help you commit to making regular contributions into your freedom with the Wealth Pie percentages and to just anchor in the way compounding works so you always having it working for - not against you.
With huge love
Ann
