Articles tagged with: saving

The magic of compound interest

9 August 2008 Michael Szumielewski 154 Comments Investing

Compound interest is one of the most interesting things in the financial world. If you truly understand how it works, it can make you a lot of money. Check out this impressive quote:

Compound interest is the greatest mathematical discovery of all time.
Albert Einstein

Compound interest can be explained as the adding of accumulated interest back to the principal. Interest is earned on interest. Compounding depends on three factors: percentage, basis and time.
Example: You have a bank account with $10000 in it and get 4% interest per year. After the first year you have $10400, but ten years later you already have $14802.44. Sounds great, doesn’t it?

Even 0.5% make a difference

Let’s take the example from above and modify the percentage to 4.5%. After ten years you have $15529.69. That means that you get 10.77% more than with a percentage of 4%. Amazing. Always seek for that extra 0.1% to 0.5% when searching for a good investment. Over time it changes a lot and you will see the difference.

The more you have, the more you will get

It’s true, rich people get richer. We earn $400 in our first example, but with a basis of $20000 we would have earned $800. The higher the basis, the higher the profits. Don’t forget to make regular payments into your savings account, so your basis gets bigger. Ideally you save money for a reason, for example your retirement. Then you need the endurance letting the money where it is for let’s say 20 years. But trust me, the motivation is great to pay in every month, because you will see amazing results and retire completely without financial problems.

Time is on your side

How long you let your money earn money is up to you, but the longer the better.
Remember, you earn money by doing nothing. And the money you earned by letting it earn more money will earn you even more money. You just put money in your account and watch it grow over time. If you don’t need the money, let it multiply. Be disciplined and patient enough and don’t touch this money.

The three factors have to work together

The whole concept of compound interest sounds great, but it is dependent on the three factors. They have to work together well, or you will get poor results. Basically, it is up to you how long you can do without the money you put in your account. It is also your choice how much you put in,dependent on how much money you have, of course. To get the max, the basis and time should be relative high, because the third factor “percentage” is aligned with risk. You get a small percentage with little to no risk but every percentage point more goes hand in hand with more risk. It is essential to find the right balance.

Sometimes it is magic

To conclude this article, here is a amazing example on compound interest at work:
“If the Native American tribe that accepted goods worth 60 guilders for the sale of Manhattan in 1626 had invested the money in a Dutch bank at 6.5% interest, compounded annually, then in 2005 their investment would be worth over €700 billion (around USD $1,000 billion), more than the assessed value of the real estate in all five boroughs of New York City. With a 6.0% interest however, the value of their investment today would have been €100 billion (7 times less!).”

Sources: Wikipedia

The latte factor: Save five dollars a day

8 February 2008 Michael Szumielewski No Comment Books

The Automatic MillionaireGetting rich is all about saving money, especially if have a low income. Saving has nothing to do with income, but everything to do with lifestyle. You have to change the way you spend money. One interesting concept of saving money every day is the latte factor. I came across this idea in David Bach’s book The Automatic Millionaire, where he points out, how important it is to save money every day by spending less on unimportant things you do not need. I recommend this book, because it is easy to read and pretty good for people who never came across the concept of saving money everyday. When you live paycheck to paycheck read this book, it will change your attitude to money.

The latte factor is based on the simple idea, that saving $5 a day will make you a millionaire. For example, it is Monday morning, you go to work and the first thing you do is checking in at Starbucks, because you need your daily coffee + muffin. From time to time you get a grand latte or whatever, so sometimes it is even more den $5. Let us assume you save $5 a day and invest them at a rate of 10%. First, let me point out, that this will save you $35/week or $150/month or $1,825/year. That is pretty nice, but it gets better. You will be millionaire in 41 years if you invest the money by an interest rate of 10%, save $10 a day and it will take you 34 years! Of course, this depends on your interest rate and savings, but remember it is just your latte money!

What if you really need your coffee every morning? Should you give up caffeine and sweets? That is a very good question, I know people who can not live without their daily latte. But why not bring it from home? Get a thermos flask and make your coffee at home. You like sweets or sandwiches for dinner? Buy your Snickers at the local supermarket in a family pack. This will cut costs at least by 50%. The same goes with water, snacks, fast food, cigarettes, magazines and so on. Just think about it! As I told you above, saving is an essential step on your way to become rich. Start today!