Interest rate effect
 

Is an incredibly powerful effect. It is claimed that Albert Einstein himself had a quote that goes like this:

 

"Compound interest is the eighth wonder of the world. He who understands it earns it ... he who does not ... pays it."

 

It is not only Einstein who has understood this. Warren Buffet, who is ranked by many as one of the best investors of all, has built one of the world's largest financial fortunes through precisely this world's 8th wonder. It is no coincidence that his authorized biography has the title: "The Snowball":

interest rate interest rate effect interest rate interest rate interest rate investment interest rate effect

What is the interest rate effect?

 

The effect arises when you receive interest on the interest rate you have previously received, and thus get exponential growth. The point is, you should invest the return you receive so that it can grow further and further.

 

Let's take an example:

 

You get the opportunity to have 1 million directly, or a magical 1 coin that doubles in value every day for 30 days. Many would probably have taken the quick 1 million deal, but if you take out the calculator you can see that the magic, the coin would have been worth much much more.

The simple formula for compound interest, if you do not consider extra deposits looks like this:

Sum after interest rate = Starting sum * (1 + interest rate / 100) ^ in number of installments (years)

In the ordinary world, this can be used in more conservative, but still very lucrative cases. Let's take an example where you as an investor have a starting sum of 0$, and will save 1,000$ a month. the next 20 years.


With a regular savings, this calculation would look like this:

 

Start sum = 0 $

Sum each month = 1000$

Annual sum = 12,000$

Period = 20 years

Total = 12,000$ * 20 = 240,000$

If you had started the same project with the interest rate effect, the calculation could have been quite different. We take an example where you as an investor managed to maintain a 5% annual return on your investments on average over the same period.

Start sum = 0$

Sum each month = 1000$

Annual savings = 12,000$

Annual return / interest = 5%

Period = 20 years

Total = 407,538$

The very formula for this with fixed saving each month can be a little difficult to get acquainted with, but the formula, as well as more information about the math, can be found here.

The essence is that re-investing gains/interest in new gains/interest can give extremely good returns over time. An "easy" way to get such an interest gain,  is by making an investment in, for example, a fund that has a return of x number of percentages per year. Historically, making such an investment has proven to give a good interest rate effect.  You can of course get the same effect if you make investments yourself in stocks. You must then be able to maintain a solid annual return, re-invest this, and avoid years with large losses over a longer period.

Interest rate calculators can be found here: