Every mathematician, accountant, and financial advisor will tell you that compound interest is a powerful force. Albert Einstein famously referred to compound interest as “the eighth wonder of the world” and the “most powerful force in the universe.” So, if someone were to tell you why compounding interest will not make you a millionaire, why would you believe them?
Why Compounding interest will not make you a millionaire
Unless you can plug in the right variables to the formula for compact interest, you will see that your money will not grow to a million dollars. Time is a key component, as is the amount you invest, and the interest rate you earn. If any of those variables are off, compound interest will not make you a million.
Suppose you could invest $10,000 today, have interest compounded daily at an 8% interest rate, and not touch that money. If you did the calculation, you would have about $50,000 after twenty years, which is nice but nowhere close to a million dollars. After paying taxes on your gains and factoring in the loss of purchasing power due to inflation, your investment would not look so good.
The above illustration shows that if you don’t start out with a large enough sum of money, don’t earn a high enough interest rate, and don’t have enough time to let your money grow, compound interest becomes a far less powerful force.
Life happens and plans change
Very few of us go through life without experiencing some type of financial crisis that forces us to draw down our savings. It could be that you are diagnosed with cancer and need money to pay for expensive treatment and cancer-fighting drugs. You could lose your job and be out of work for two years. Anything can happen at anytime and you may have no choice but to access the nest egg you had been building up for the last 20 years. That will set you back and make it more difficult for the power of compounding to work its magic.
Your rate of return can change
If you are invested in the stock market, and are happily watching your portfolio go up year-after-year. That can end suddenly. One bear market, where you lose 30% of the amount invested in your portfolio, can halt your climb to a million dollars. If the value of your portfolio dropped from $100,000 to $70,000, you would need your portfolio to rise by close to 50% ($70,000 x 150% = $105,000) just to get back to where you started. You’ll have to reset your compound interest calculator and hope for a great bull market and years of above-average returns.
An Alternative Investment that can make you a millionaire
Real estate is the path that many people follow on their way to becoming a millionaire. Over time, you build equity and property prices appreciate in value. Additionally, you can increase the rate of return on your investment by collecting rent while you wait for the right time to sell.
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