The Eighth Wonder of the World and the Power of Small Numbers
“Compound interest is the eight wonder of the world. He who understands it, earns it; he who doesn’t, pays it.” — Sir Albert Einstein.
In simple words, compounding earns you interest on interest. Let’s say you have $100 and you invested it in a stock or a mutual fund that earns you 10% interest. Now you have $110 at the end of Year 1. For Year 2, you will earn 10% on $110, not on $100. Now you have $121 at the end of Year 2. In approximately 7.2 years, you would have doubled your $100 investment and in 10 years you would end up with roughly $259.37
So how can I apply compounding to my own advantage and grow my wealth?
Let’s say you buy coffee from your local café five days a week. This can cost you roughly $100 a month assuming coffee/snacks costs $5. Now you decide to purchase coffee only four days a week instead of five and invest the remaining amount in a low cost, index mutual fund. At this point, you are investing $20 per month. The table below shows you the amount of money you would have, given the average rate of return, in 10 years and 45 years if you invested small amounts of money monthly. This is power of compounding! Small amounts of money invested over longer periods of time can turn in huge pile of cash. The sooner you start, the better!
To put this into perspective, just think of an expense that you can save and select a multiplier from the table below. You will get a sense of how much money you can save by just eliminating the expense you no longer need to indulge in. You can play with the compound interest calculator here and estimate the amount for a different time frame.
Key Takeaways -
- You do not need a huge sum of money to being investing. Do NOT underestimate the power of small numbers!
- If you do not have enough savings to begin investing, start small. But most importantly, start EARLY. Time is the key!
- A tiny change in an average rate of return over a long period of time can make a huge difference.
- Your savings rate, annual rate of return and investing time horizon are the key parameters.
So eliminate redundant, unnecessary expenses. Below are few tips that will help think of ways you can save money, some of which, I too, have implemented.
- Cell Phone Service — Consider switching to a Mobile Virtual Network Operator (MVNO) for your cell service. MVNOs do not own the infrastructure that the big cell carriers need to maintain and thus are able to offer services at very low rates. Switching to an MVNO has helped me save over $50/month (that’s $600/year, which you can invest). Some MVNOs offer plans for as low as $15/month.
- Local Laundromat — If you do not have access to washers and dryers in your apartment, consider trying out your local laundromat. Renting washers and dryers can cost you around $45/month to $55/month. Plus they increase your electricity and water usage and bills.
- Auto/Renters Insurance — Consider increasing your deductible. This, in most cases, will reduce the premium you are paying.
- Electricity Provider — Contact your local utility to see if you qualify for their energy efficiency program offering. Utilities offer energy savings kits that include free LEDs, showerheads, advanced power strips, aerators and other weatherization measures that can save electricity and reduce your monthly electricity bill.
- Learn to Cook — try cooking once in a while at home if you tend to eat daily outside. See if it affects your lifestyle significantly and becomes a positive reinforcement. Cooking is happiness :)
- Subscriptions — revisit your monthly channel/magazine/TV/media/wholesale club subscriptions and cancel the ones you do not use.
- Learn to Negotiate — If you do not negotiate and ask for a better deal, you won’t get it! It doesn’t hurt to ask. Negotiate your monthly internet bill/insurance bill. Get a quote from other providers and switch if you are not satisfied. Negotiate with banks on fees you may be paying. Most banks will waive off late fees if you have had a good history of paying your credit card bills on time. So always call and ask.
- Do your Homework — if you are planning to make an important purchase (for e.g., car), always do you homework on the price that you should be paying. Most salesman/dealers will try to convince you on buying that extra feature or a plan that you may not need. Take a step back and assess the need. If you have done your research, you will be able to ask the right question to the salesman/dealer and that person will not be able to sway you into making an unnecessary purchase.
These are just a few tips. Once you start implementing these saving habits in your life, you will soon realize how quickly the small numbers add up. And then put those hard earned and well saved dollars to work for you by investing them. You may realize that these decisions you make, do not affect or change your standard of living significantly or that you are not sacrificing your happiness in a big way. Instead, you are able to make the most from less and are investing the rest. The money will compound and will work for you. So, think how you can maximize your savings, and in turn, your happiness. Keep saving and investing for a better future and let compounding do all the magic!
If you have additional tips on ways to maximize savings, feel free to drop a comment. And remember… Every Cent you invest, has a ton of Potential to grow!
