Use the force young Jedi, the force of compounding!
We talk a lot about the secret force of compounding because it is the hidden mathematical force that anyone can harness to build wealth. It is not really a secret, but a lot of people just do not realize how powerful it can be in terms of helping you build wealth. Just like Luke Skywalker uses the force as a Jedi, you will want to use the force of compounding to grow your investments. It is so powerful that it must be embraced and understood to achieve financial freedom. It’s basically earning interest off your interest. It’s a feedback loop that adds to itself if you give it the magic ingredient of time.
So, let’s say you worked your butt off as an entry level stormtrooper for ten years, day in and day out toiling away to sustain the Empire. You were able to sock away that first $50,000 in your investment account. Here is the great news and the way to harness the force: The next $50,000 should be easier to achieve since you already have that initial amount in. This is due to the “force” of compounding. Basically, each one of those $50,000 is now your employee, working to spin off interest that is re-invested. But the real power is just beginning, because then each one of the new dollars starts working for you as well, and so on and so forth. In other words, continually reinvesting your gains leads to astronomical growth over time.
A simple example: Let’s say you invest $200/month in your index funds over the course of 20 years. This sounds like a long time, but it goes by faster than we think. At the end of that period you would have put $48,000 in that account, but through the power of compounding it could be worth over $100,000 at 7% interest. This is only 4% or less of a typical person’s salary. Ride this out for 30 years, a typical working time period and you end up with almost $250,000, a medium size fortune from a very small investment each month!
How to harness the force:
A. It is simple, invest automatically in a low cost index fund every month and let the money be. Think of it as fenced off. This gives the compounding time to take effect. I also enjoy investing in Dividend Reinvestment Plans (DRIPS) and watching the dividends compound and become reinvested into additional shares. Those shares in turn make even more dividend contributions and so on and so forth.
B. Harness the spirit of compounding in your life. Each small act you take will build on itself and form into a healthy habit. Over time these “habits” compound into a powerful force. This is one reason we launched the 30 day Small Steps to Build Wealth Challenge.
Darth Vader Will Use the Death Strangle Against You
Debt! Most Debt! Bad Debt! It will choke your ability to grow and build wealth. Darth Vader uses compounding in reverse. It chokes off the ability of the investments to grow. Below are a couple rules to try and live by. Unfortunately I have made a few of these mistakes and am trying to make up for lost time. Because that is what this is about, giving our investments the time they need.
A. Do not borrow from your 401k if you don’t have too. I borrowed a few years ago to help buy my house. I live in an expensive area when it comes to real estate. I have since paid this back to my 401k. But I lost out on some compounding.
B. Avoid high interest debt and debt in general, this is compounding working against you. You are making someone else rich so you can be surrounded by a bunch of consumer junk you never needed to begin with.
Luke Skywalker and Leia Organa, go use the force that is free to you right now. All it really takes is having a percentage of our salaries stashed in low cost index funds and not touching them for 10, 20, 30 years. Be a strong Money Viking and pump those contributions to the max and maximize the force. Take that Vader!