We know that every investment article, blog, website and product makes a point to tell you about compounding. Some say it's the holy grail. Some say it's the most powerful force in the universe. Everyone agrees it's the greatest thing since sliced bread.
For a long time, the most important question when we had about compounding and compound interest was simply "How exactly does compound interest work? And why is this important to my investments?"
That is the question we're going to answer today. How does compounding work and why does it matter?
How Does Compound Interest Work?
Well, this part is really simple. Picture $100. This is the amount you invest. Your returns or interest rate is 10%. That's a simple $10 you earn. That's it. If it's $1,000 then your 10% is $100. Simple. Nothing complicated with that right? In fact, it's so simple, this form of interest is known as simple interest. Laziest name in the world. If every time you earn $100 you spend it, come around in another investment period, another $100 will roll around. Like the goose that lays one golden egg a day. Stable, consistent and no surprises. Just 10%.
Then in comes compounding. Compounding is a fancy way of saying, you are reinvesting each interest you earn. That's all compounding is. We reinvest our interest. If you invest $1,000. You earn $100. When you reinvest that $100, your investment is no longer $1,000, it's now $1,100. So with the same 10% return, your interest will go from $100 to $110. So you reinvest again. You take that $110 and add it back to your investment. So now, your investment is no longer $1,100, it's now $1,210. And your 10% on that now earns you $121. You take that $121 and add it back to your investment so it goes from $1210 to $1,331. Remember all this started from $1,000. The remaining $331 came from you reinvesting each interest you earn in a period, usually one year. That's what compounding is. The difference between simple interest and compound interest is that you're reinvesting each interest you earn, which means your overall investment keeps growing by the interest amount which also keeps growing because the principal is growing. It's a feed back loop.
So far what we have is this: invest principal, earn interest. Simple interest.
Invest principal, earn interest. Reinvest interest leading to bigger principal, earn bigger interest. Reinvest bigger interest into bigger principal, earn even bigger interest. That's compound interest.
Again: earn interest (simple interest). Earn interest on interest (compound interest). Take time to really understand that. Read it twice if you have to.
Because now we get to why compound interest is so important, why it's so hyped, why it's talked about with such lofty terms.
Why Is Compound Interest So Important?
Because of what it becomes or results to, over time. That's it. The magic of compounding, and therefore all of investing is what it becomes over time. Let me show you how. You see how we started with $100 interest but we keep reinvesting it and by year 3 we have $331 extra, and $1,331 in total? 1. That's $31 higher than we would have had if we only earned $100 simple interest every year for three years. $31 is not that much. But the best part is, as that principal portion continues to grow, the interest portion on the original $1,000 continues to grow annually from $331 in year 3 to $464 in year 4, $610 in year 5, $772 in year 6, $948 in year seven (which means our total investment is $1,948 at this point) until in year 8 it becomes $1,143 bringing our total investment to $2,143.
So it took us 8 years to rack up to $1,000 in interest on our original investment. That means we would have earned more in interest than we originally started with in investments. Not bad but not completely mind blowing either. 8 years after all is a long time.
But compounding builds on itself. Now that our principal has doubled, thanks to all the reinvesting, it only takes another 4 years to add another $1,000 to our principal if we continue to reinvest our interest or compound it.
So another 4 years would take us from $2,143 to $3,137. Time to hit $1,000 of interest earnings has gone from 8 years when we began, to 4 years. That means our money is growing at a much faster rate now.
We continue to reinvest. In another 3 years of reinvesting we hit $4,176. That means we've added another $1,039 in 3 years, so time to $1,000 is less than 3 years now.
In another exactly 2 years we cross $5,100. So time to $1,000 is now 2 years.
Before you know it, it's growing at $1,000 every year. We keep reinvesting it starts growing at $2,000 a year, or $1,000 every 6 months. Keep going, it's growing at $3,000 a year, then $4,000 a year.
By the time you've compounded for 4 to 5 decades, you've crossed $110,000 and your interest is growing at $8,000 to $12,000 annually, far bigger than your original $1,000 investment, or the $100 interest you started out earning.
All of this assumes of course that you only invest that original $1,000. If you actually take your investment seriously, you would have been adding maybe $1,000 every month, or every quarter, or even every year. The result would have been that you'd be sitting on hundreds of thousands, maybe millions in 2-3 decades and definitely tens of thousands in a few years.
And much of that would have been a reinforced growth coming from the interest you continue to reinvest and the additions you continue to make into your principal.
That is one reason why investing is really really not a single year or a single period game. Not a lot of things will earn sufficient interest in a single period to be meaningful in a single period (and if they do they're either too risky, too volatile or a ponzi).
But if you can earn a consistent return, in small dozes, compounded over a really long time, then you will be astonished at the results.
So what Do I Do With This New knowledge?
Why, invest in Cashestate, of course! That's why we designed a portfolio that selects highly vetted real estate properties that continue to earn a consistent dollar-denominated return from annual rental cash flow and capital appreciation. The quality of assets and the fact that they're real properties, in growing areas, that will earn return and grow in value over time means that your returns will continue to compound and grow as you reinvest it.
Our minimums are $1,000, our expected returns are 10-13% annually, and we have a dedicated team that finds the best deals and puts your money to work on them.The fact the returns and investments are in dollars means high Naira inflation is not eating away the value of your returns, and in case of a devaluation, your investments actually become more valuable. It's the best investment opportunity we can think of.
Fund today, and continue to fund and reinvest over time. Let the results surprise you.