The existence of compound interest speaks to the latter. And it’s exactly why compound interest is one of the safest, most effective mechanisms for growing wealth in existence.

Albert Einstein called compound interest the “greatest mathematical discovery of all time.”

But fortunately, understanding and capitalizing on compound interest doesn’t require the mental capacity of a genius like Einstein.

What is Compound Interest?

Compound interest occurs when you add accumulated interest back to the principal. As a result, interest is earned on interest on a perpetual basis thereby increasing your overall investment amount exponentially over time.

Although you can quite easily use a compound interest calculator to input the values unique to your financial situation, here is just one example of the awesome power of compound interest:

If you save one hundred dollars each month for forty years and your investment compounds at 12% annually, how much will you have? $980,000.

How Compound Interest Works

Compound Interest is often likened to the snowball effect. As your investment rolls down the hill it grows at an accelerated pace. Even with a small snowball to begin with, an exceptionally large one will result over time.

Compound Interest is based on two variables – the length of investment and the rate of return. Simply put, the longer your money is left to grow, the faster it will balloon. Similarly, the higher the interest rate you earn on your money, the higher the invested amount will become over the duration of the investment.

If you’ve ever wondered why it seems easier to stay rich than it is to become rich, it’s largely because of this mathematical phenomenon known as compound interest.

Yet, even if you are not already independently wealthy, there are simple steps that can be taken to yield big returns in the long run. For example, most people spend at least one dollar each day on some form of refreshment. Over the course of one month, however, if each dollar is directed instead to an investment account accruing compound interest at an 8% annual return, after a forty-year period elapses, you will have earned a whopping $101,372.91.

The only potential drawback associated with making compound interest the centerpiece of your investment strategy is that the rate of interest may not be the same every month. And because the rate may fluctuate (5% the first month, 3% the next month, etc.) a lot of investors still prefer to maintain the more stable and consistent – yet lower rate – of return by foregoing compound interest and, in its place, keeping their money in a simple savings account.

Making Compound Interest Work for You

Compound interest doesn’t work overnight. Throughout the duration of your investment, it is pivotal to patiently add, not withdraw from your investment if you are going to experience the awesome power of compound interest in full.

By working hard and having your money work hard for you, the path to fiscal strength and lifelong solvency will be clear and much easier to follow.

Photo by pinksherbert

Pack a Lunch

This should be the first thing you do if you are trying to save money. This one thing alone can keep around $1,000 in your pocket each year.

Drink Water

At home and especially out to eat. Think about how much money you pay for a soft drink in a restaurant. At $3-$4 a time, this saving can really add up. At home, drink water instead of soft drinks, and invest in a reusable water bottle and fill it up at home before you go out. If you want, purchase a filter pitcher and filter your own water before drinking it. An added bonus to drinking water is that your body will feel better in the long run.

Coupons

There is an art to couponing, but those who do it well save heaps of cash each month. The key here is to time a manufacturer’s coupon with a local sale and double up on savings. Most discount coupons offered by a store won’t be valid with any other store sponsored sale, but a retailer gets paid for every coupon distributed by the manufacturer of a product, so they don’t care if it is already on sale.

My friend had a coupon for $1 off some juice the other day and used when the store ran a buy one get one free sale. She got one dollar off the juice she paid for and the free one, making both juices almost free. It can be a pain to keep up with, but it is well worth the effort as it can save thousands each year. Check out Tjoos for a huge assortment of manufacturers coupons available online. All you do is print them out and go.

Dump Cable

Do you really need or have time to watch all of those cable channels? With cable packages running as high as $130 a month, you could save a lot of money and free up some time as well. Even if you just dropped down to the basic package, which you can usually get for $40, you can still save up to $90 a month or $1,000 a year.

Go Wireless

Drop your home phone and just use your mobile. That will save you at least $30 a month, if not more. Plus you simplify your life by only having to deal with one phone number. At the very least, get rid of any extras you have with the phone line.

Use the Library

This works for books and internet access. Why buy a book that you will most likely only read once (if that). While running to the library to use the internet can be a huge pain, if you are in survival mode it will cut $40 or more off of your monthly bills.

Maintain

I know this isn’t a sexy tip, or even one that you can quantify, but properly maintaining your auto, home, and other possessions will save on repair bills in the long run. I like to think of it as a stealth savings, since you don’t really know how much you are saving, but trust me, you are saving.

Time the Petrol Market

Petrol prices are volatile right now. When petrol prices are falling, top off occasionally instead of filling up so you can continually take advantage of the falling prices. When the prices are rising fill up so you get a full tank before the price goes up.

Like it Hot (or not)

For every degree you turn up your thermostat, you can save 10% on your cooling bill, which adds up in a hurry. Adjust your hot water heater thermostat down to save money on heating your water. If you need to add cold water to the hot to wash your hands, it is set too high.

Clean

Use a mop and broom and old-fashioned vacuum to clean the house. Don’t buy those fancy mops that require expensive (or even cheap) refills. Use rags as opposed to paper towels to clean, and consider ditching your store bought cleaners for a home made mixture of vinegar or ammonia and water.

Bonus Tip

If you have a baby, use cloth nappies. They cost a few hundred to get set up but will save you thousands over the nappy life time of a baby. Most babies stop using them at around two and a half years old, so think about how many nappies that really is. Plus, using cloth helps keep disposable nappies out of landfills.

Photo by Stewf