Albert Einstein called it the eighth wonder of the world. He noted that compounding is the most powerful principle in the universe.
Warren Buffett was once asked how did he accumulate his wealth. His response was "good genes and compound interest."
Renowned economist Burton Malkiel once said that the biggest mistake people are making today is that "they do not tap into the power of compounding interest.' We all know about it intellectually, but it is a force that will make you wealthy."
Most people who have taken advantage of compound interest started out with a very small fortune. On the contrary, many former wealthy people who started out with a big fortune lost it all due to their failure of utilizing compound interest. As a former collegiate athlete, I have identified a few former pro athletes who went broke because they did not take advantage of compound interest.
Curt Schilling, former Boston Red Sox star pitcher, made over $115 million dollars during his stellar 20-year career. In 2012 he lost everything he had to the tune of $50+ million dollars when his video game company 38 Studios went bankrupt.
He took a huge risk by sinking all of his eggs in one basket in search of the home run ball, and unfortunately, he struck out and lost big!
Things may have turned out a lot differently for Curt Schilling if he had taken advantage of compound interest. For example, if he had invested just a modest 10% of his earnings into a conservative portfolio with an average return of 6% over his 20-year career span, he would have amassed a fortune of at least $36.8 million.
Antoine Walker earned more than $108 million during his career and filed for bankruptcy just 2 years after retiring from basketball. As with many sports stars who obtain instant wealth, they create a very expensive lifestyle for themselves right at the start of their career without giving the slightest thought to their future, and Antoine Walker was no exception.
Antoine admitted that he was financially supporting at least 30 or so friends and family members. It is very sad when your own friends and family members do not have your best interest at heart but unfortunately, this is a common occurrence among professional athletes.
Aside from financially supporting everyone around him, Antoine spent the majority of his fortune on homes, jewelry, and a real estate company that went bankrupt. Antoine Walker could have avoided financial ruin if he had taken advantage of compound interest.
Mike Tyson earned more than $300 million over the course of his illustrious career and he lost it all, having to file for bankruptcy in 2003. Tyson went on record stating that he blew most of his fortune on mansions, cars, jewelry, and prostitutes.
Let's go back to our previous example with Curt Schilling. If Mike Tyson had invested just a modest 10% of his earnings into a conservative portfolio with an average return of 6% over a 20-year time span, he would have amassed a fortune of at least $96 million!
Tyson admitted that people severely took advantage of him financially during his boxing career, and says that calling them 'leaches' would be an understatement.
But see here's the thing, whomever you choose to surround yourself with and take advantage of you is your own fault and no one else's.
I used these examples to make a point, and the point is that gaining instant wealth does not guarantee a secure financial future. To further emphasize this point I would like to point out that the majority of self-made millionaires did not get there by receiving an instant fortune like the former athletes mentioned above did.
Most self-made millionaires got there by starting out with modest incomes, living within their means, and by investing modest sums that gradually grew over a period of time because of this wonderful thing called compound interest!
What exactly is compound interest and how does it work?
Compound interest is when your wealth undergoes compounded growth over a period of time. How does it work? Let's take a look...
Let's say that you invest $100 into an investment portfolio that is earning an average return of 6%. In year one your $100 will have earned $6, and your portfolio is now worth $106.
If your portfolio earns another 6% in year two the total earnings will now be $6.36, and your portfolio will now be worth $112.36 (106 + 6.36). This is the beauty of compound interest because each year your entire investment portfolio receive earnings on the 6%, and not just the original investment amount of $100. If this investment portfolio continues to earn an average of 6% in returns over 20 years it will be worth $320.71 by year 20.
If the original investment amount was $10,000 your portfolio would be worth at least $32,000 by year 20.
If the original investment amount was $50,000 your portfolio would be worth at least $160,000 by year 20.
If the original investment amount was $500,000 your portfolio would be worth at least $1.6 million by year 20.
Keep in mind that the above-mentioned scenarios are only factoring in a one-time investment of the original amount. So just imagine if you were to actually add a little bit of money to your investment portfolio over the 20 year time span...the growth will be that much more astounding!
This is how long-term generational wealth is established.
Investing for the long-term with a patient and disciplined approach is how the majority of self-made millionaires have achieved their status.
Rarely does one achieve long-term generational wealth by jumping in and out of the markets with some type of market timing strategy.
Rarely does one achieve long-term generational wealth by taking on substantial risk on the latest trending tech stock.
Rarely does one achieve long-term generational wealth by taking on substantial risk on the latest craze such as bitcoin.
Compound interest does not apply to those who are jumping in on some type of get-rich-quick strategy. The full power of compound interest can only be exploited by those who take on a disciplined, patient, long-term investment approach.
So the question is are you going to place your bets on some get rich quick strategy, or let your money sit idle in a savings account, or take full advantage of compound interest?
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Disclaimer: Hudson Wealth Management, LLC (HWM) is a FINRA registered investment adviser firm. Investing in securities involves risks, and there is always the potential of losing money when you invest in securities. Before investing, consider your investment objectives and HWM's fee schedule. The information provided herein is for illustrative purposes only and does not constitute personalized investment advice, recommendations or solicitations to hold, buy or sell any investment or security of any kind. All images and return figures shown are for illustrative purposes only and are not actual customer or model returns. Past performance does not guarantee future results.
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