Those who wish to become rich or aspire to become a millionaire should learn the power of compounding (the ‘magic of compound interest’) – a key element of wealth creation that has helped millions of people literally become millionaires. This little advertised strategy of investing and wealth management is not a ‘get rich quick’ scheme, but yet a very powerful and simple strategy used by financial advisors as well as savvy individuals for private wealth creation. The power of compounding is a great strategy for retirement accounts as a key element of investing in IRAs and other retirement accounts is that the monies must be left untouched for many years before being withdrawn – which forces one to use the effect of time (and the power of compounding) to grow one’s nest egg. In fact, the power of compounding is considered by many to be so great a discovery that it has been ascribed to none other than Albert Einstein (although this may be an urban myth not supported by data: Albert Einstein has been quoted to have said “The most powerful force in the universe is compound interest.”)
Become Rich by Starting Early and using the Power of Compounding
To illustrate the power of compounding to help anyone become rich and why it is essential to begin early, I have generated a table with the following two scenarios with young teenagers both starting out at McDonalds at the age of 16 years.
- One decides to save $10/week, and does so faithfully for 10 years, and then stops.
- The second squanders his money initially, but begins saving $10/week like the first, but for the rest of his working life.
Both invest their money in the same retirement account, and retire at the age of 67 years.
The table below shows that for any (10, 11 or 12%) rate of compound interest, the one who started earlier (and then stopped) still ended up with twice as much money than the one who started later. This is because the power of compounding increases with time. Ironically, the one who started later also contributed four times as much as the one who started earlier.
Moral of this story is – TO BECOME RICH START INVESTING EARLY!
Additional Lessons about the ‘Power of Compounding’
- For those of you who read this and are yet ‘young’ – NOW is the time to begin investing to harness the power of compounding!
- For those of you who did not start young – Despair not, there is still hope – read on! The Power of Compounding can yet work its magic to help you become rich.
- For those of you who say “What’s all this got to do with Options and Trading?” – Everything – especially, if you are not young and have time on your side. You can still use the power of compounding, except you will need to be creative in its use.
Let’s examine three scenarios (with tables and data to prove our assumptions):
How to become rich by using the Power of Compounding: Scenario 1
In the above Table, one scenario was that of a 12% return per year – this can be equated to 1% per month. If we are able to increase our returns to 2% per month (and stock options expire every month!), we will have the equivalent of a return of 24% per year. The Table below shows the effect of such a return on one’s savings – we would become millionaires in less than 30 years investing just $10/week using the ‘magic’ power of compounding.
How to become rich by using the Power of Compounding: Scenario 2
What if we were able to invest $100/per week instead of the $10/per week in the prior example, and had a return of 2% per month compounded annually. We’d become a millionaire in less than 20 years (18 to be exact).
How to become rich by using the Power of Compounding: Scenario 3
What if we were to invest $100/week, and had a return of 2% per month, but compounded monthly. In this case, we’d become millionaires in a mere 132 months (11 years) as we’ve greatly enhanced the power of compounding by compounding more often!
The real secret to becoming rich is to be able to make consistent profits, and to put the power of compounding to work by reinvesting the profits.
By learning how to trade stock options profitably and making as little as 2% a month consistently you will gain a powerful edge over the majority of individual investors and traders who seem inevitably lose money in the stock market if you learn to harness the power of compounding. If you can put the above principles to work and invest more than the $10 or $100/= mentioned in the above examples or if you can achieve more than a 2% a month return you will unquestionably achieve your goal faster than shown above. You could be a millionaire in less than 11 years!
A little known fact is that you can use stock option strategies within an IRA (investment retirement account). This will allow the power of compounding to work more effectively because you do not have to pay taxes on your gains. Check out the OptionsXpress link below for more information on using stock option strategies within an IRA. If your current broker does not permit options trading within IRAs, it may be time to switch brokers.
If you are new to stock investing and options trading, you should read How to Learn Investing and Trading before delving into stock options trading. Take time to learn before you put real money at risk – like any venture, it takes time to learn how to trade stock options well and how to manage risk. You can lose all your money in the stock market and trading options if you don’t know what you are going.
If you are already trading, visit The Option Traders Blog to see examples (with broker confirmations) of how you can easily make more than a 2% return using option trading strategies.
Good Luck in your quest to become rich!