A Crazy Kid with a Crazy Idea
I loved mangoes when I was a kid and still do now. So when I learned that this sweet golden bundle of deliciousness came from trees, my naïve mind came up with a crazy idea.
What if we have our own mango tree!?
One day, I hastily consumed one, ran outside with the seed, and started digging with my tiny hands until it was deep enough to cover the mango seed. Of course, that seed would not grow, but in my head, I could not wait for the day when I could pluck and eat as many as I could, and I would love to devour mangoes happily ever after.
Today, I am still that kid with crazy ideas. But this time, I would say I want something more than mangoes, more than stuff or money. I want to take back our time. We want our freedom.
They say that money does not grow on trees, but what if it can grow like one? Would it be possible to grow your own financial independence tree so you can live happily ever after on it?
In this post, we will discover how this is possible through compound interest.
What is Compound Interest?
Compound interest is when you earn interest on your money with the accumulated interest it made. It is gaining interest in the goods you receive. Ancient Babylonians called it “şibāt şibtim,” which is “interest on interest,” when they conceived it almost 4000 years ago.
This method of accumulating interest makes your money grow exponentially. It grows while you work your 9-to-5 and even while you sleep. Albert Einstein most famously stated that compound interest is the most potent force in the universe. I believe him. He was literally a genius, after all.
To see it in action, let us know what happens if we invest $1000 on an account that will give us 10% interest compounded yearly and leave it there for 20 years.
In Year 1, our investment will earn 10% of $1000, which is $1100. Making this our new amount.
In Year 2, the interest will be calculated on that new amount ($1100 + 10% of $1100 = $1210). Every year this will go on as long as we have money invested.
|Years||Total Contributions||Future Value|
|Year 0||$ 1,000.00||$ 1,000.00|
|Year 1||$ 1,000.00||$ 1,100.00|
|Year 2||$ 1,000.00||$ 1,210.00|
|Year 3||$ 1,000.00||$ 1,331.00|
|Year 4||$ 1,000.00||$ 1,464.10|
|Year 5||$ 1,000.00||$ 1,610.51|
|Year 8||$ 1,000.00||$ 2,143.59|
|Year 11||$ 1,000.00||$ 2,853.12|
|Year 12||$ 1,000.00||$ 3,138.43|
|Year 17||$ 1,000.00||$ 5,054.47|
|Year 20||$ 1,000.00||$ 6,727.50|
We will not see significant growth for a few years, but in the 8th year, our investment will double; it will be three times in 12 years and almost seven times its value in 20 years. This is nothing besides saving and investing $1000 and letting compound interest work its magic.
Compound interest is not an overnight, too-good-to-be-true, get-rich-quick scheme. It is slow initially and quite dull, like watching grass grow. But after the momentum builds up, you will see how it accelerates your FI. Just be patient.
The Time Value of Money
This Old Chinese proverb beautifully touches on the Time Value of Money. This concept states that the money you have today is worth more than the same amount in the future because the money you have now can earn more in time.
You must have time to take advantage of this wonder of an invention. The sooner you start saving and investing, the more accumulated interest it earns. You go on with your day as usual (wake up, work, sleep, repeat), and your money will do the growing for you if you don’t touch it until it is ready.
Although younger investors do not have much money to invest, time is their most potent edge. More chance for the seedling to grow roots, strong trunk, and sturdy branches that would bear luscious fruits of financial freedom.
|Starting Age||Initial Investment||Monthly Contribution||Interest Rate||Money at Age 60|
As you can see on the table, a kid fresh out of college, earning less and therefore saving less, will have more money than someone in their 40s, earning more money and saving twice as much, when they both retire at 60
Like my mango tree, it will take time for you to enjoy your fruits after planting the seed, which is what an early investor has. It requires a little bit of your attention and a lot of your patience to see this through.
Rate of Return
The following vital factor to compound your money is the rate of return. This is the measure of your earnings as a percentage of your investment.
A higher rate of return will result in faster growth of your money, but chasing high returns also comes with higher risk.
At the writing of this post, the interest rates for savings accounts on brick-and-mortar banks are at 0.01%, online banks at 0.40 – 0.60%, and CDs at 0.50 – 0.60%. These returns are okay, but we thought our money would be put to better work invested in the stock market.
In the stock market, you do not earn a fixed interest rate but rather a return based on the change in the value of your investment. Therefore, if you keep your money and the returns invested, it will grow over time in the same way as interest is compounded.
We chose to plant our FI seeds on the U.S. total stock market, with an average of 8 – 12% annual growth. Advise on where to put your money is beyond the scope of this article. Please take time to do your own research before you invest. Keep in mind that higher returns always bring more elevated risk.
Our Financial Independence Tree
In our previous article, When Can I Retire? We found that we are set to reach financial independence in 13.5 years but did not factor in growth from compound interest.
Let us factor that in. What will be our new timeline if we invest the majority of our 2019 Net Worth ($46,104.55) in a U.S. total stock market fund with a projected 10% rate of return compounded annually while contributing $7395 monthly.
When we factor in compound interest, we want to reach financial independence and retire in 9 years (4 years earlier). However, if we choose to work until the 13th year, we will have almost double our FI number. This is because our money would grow accelerated as we reinvest earnings to get additional shares and compound them with our monthly contributions.
This is the miracle of compound interest. No wonder Mr. Einstein dubbed it the Eighth Wonder of the World and man’s greatest invention. It is a powerful force to grow your wealth if you are committed to seeing it through.
You don’t have to save thousands of dollars to use compound interest. But, saving a little bit early and often can put this strong wind behind your sails toward your journey to financial independence.
Are you ready to plant your retirement tree? The best time to start is NOW. First, fertilize your savings with compound interest. Then, watch it grow patiently and with perseverance. You will enjoy the fruits of financial freedom in no time.
We are a Pinoy Physical Therapist duo living somewhat unconventional but intentional lives. Trying to be smarter and better than before, we surround ourselves with content, experiences, and people that help us discover practical yet powerful ways to achieve our goals.
We aim to be financially independent by making small changes to our lives. We invite you to join our journey! We hope that you learn something valuable from our experiences.
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We are NOT certified financial advisors, analysts, or CPAs. Investing strategies shared in this article and the website are not financial advice but our opinions for educational purposes only. We want you to treat our content as a preview to do your research so you can make intelligent financial decisions.
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