The point is that many people stay at this point, they assume that they need a lot of money to invest, so they postpone a series of decisions that they must make to work for their financial freedom.
Based on this, we will talk about the magic of compound interest and how it can help us put ourselves in a winning position regarding our financial goals.
The magic of compound interest:
So how do we put money to work for us? How do we take advantage of compound interest? The first thing we must do is change certain habits in our lifestyle and understand how money works.
There is a saying that “the millions take care of themselves, what we have to take care of are the pennies”. Ask yourself, how are your daily expenses? What do these expenses say about your financial education? How much do they help with your financial goals?
The first step to building your wealth is to be clear that it is the daily expenses, those that go unnoticed in your finances, that affect your finances.
Many unnecessary daily expenses affect your pocket and that could be easily avoided. For example, let’s talk about personal costs, such as for me, coffee.
The Million Dollar Cafe:
The latte factor is the term that will allow us to understand how compound interest can work in our favor if we have the basic knowledge, or it could bankrupt us and leave us in financial trouble without knowing how to get out of debt.
Personally, I quite like coffee. I could easily take one every day. Every morning on my way to work, I consider making a quick stop for coffee, the fuel to kick-start the work day.
In other words, coffee represents that daily expense that affects my personal finances.
At first, before reading about the effects of long-term compound interest, I thought there was nothing wrong with drinking the coffee that I liked so much, what’s more, I thought that’s what I was working for, to give me that kind of taste.
However, the effect of drinking coffee every morning has negative effects beyond my personal finances. Let’s see some:
The main component of coffee is caffeine, which, researching and reading on the Internet, according to a Quartz article, has negative effects on our health.
For example, it makes us dependent like any other drug, it deprives us of sleep, and worse, it activates the secretion of adrenaline (which prevents us from thinking clearly due to the blockage of particular cognitive abilities).
The fact of having a coffee every day means that, in the long term, I lose pleasure in my coffee routine.
Going to the beach once a year is not the same as seeing it every day. Satisfaction is found in the occasion, not in the routine.
So, my experience of coffee in the morning every day was losing its magic, in addition to generating in me the need for coffee.
And finally, the main point of this article is the financial effect of having a $5 coffee every day in the morning.
The negative effect of compound interest:
David Bach, the author of the book The Automatic Millionaire, who coined the term Latte Factor in English (The Latte Factor), argues that we are missing out on earning a large sum of money in the long run due to our daily consumption habits. In his own words:
“We will be able to save a lot of money if we eliminate our daily $5 coffee that we drink every morning as part of our routine”
Let’s take the example that you like coffee a lot, like me, and you usually drink one daily. This insignificant routine, which you already practice even automatically, represents around 35 dollars a week or 150 dollars a month.
Now, it is important to clarify that this negative effect of compound interest applies to any type of insignificant daily expense that you have:
It can be a coffee, a donut, a bottle of sparkling water, a lunch, an impulse buy every weekend at a mall, in short, any small amount of spending that you make almost “automatically”.
It is not about depriving yourself only of your pleasures:
If you like coffee, take it. If you enjoy your donut, lunch, or ice cream, do so with no regrets. Do it, the purpose of your life is to enjoy and live fully.
However, don’t fall into the trap of making it a routine, losing the pleasure of occasionally, and, above all, affecting your personal finances.
Now, if you want to start harnessing the power of compound interest, you don’t just have to stop taking on these unnecessary expenses and start investing your money.
Saving the money in your account is not enough. Read very well: You will not get rich because you stop drinking coffee, you will get rich because you will use this money and put it to work for you.
You are probably thinking that with 5 dollars a day it is impossible to get rich, which is why you decide not to try and prefer to continue with your routines and habits, hoping that by magic, you will become a millionaire and start earning money fast.
So, how do you take advantage of these few dollars a day that you will be losing to invest in your financial future? This is where the compound interest comes in.
The long-term compound interest formula:
To maximize the results of compound interest, time will be our best asset.
For example, if you decide to invest these 150 dollars per month, at an annual interest rate of 10%, that is to say, this money will generate 10% each year, something that is not unreasonable at all, within 40 years you will have accumulated 948,611 dollars.
Yes, almost a million dollars at the tip of money that you used to buy your coffee.
In the Rich Mind ebook, the author explains how this, and other 50 practical tips, to immediately improve your personal finances.
What is compound interest?
It can be said that compound interest is a kind of snowball effect, where not only do you earn money on the capital you invest but, over time, the interest becomes part of the capital, which generates exponential growth.
In short, the interest you earn also generates new interest.
To give you an example, analyze the following:
Assume you invest $1,000 at 5% per year. This means that at the end of the year you will have made a profit of $50.
For the following year, your capital will be 1,050 dollars, for which you will obtain a return of 52.50 dollars.
In the third year, your capital would be 1,102.5 (1,050+52.20), which would generate a profit of 55,125 dollars so on…
How long would it take to double your capital?
The higher your interest rate, the faster you can see the effect of compound interest. To find out how long you can double your money, that is, convert the 1,000 dollars in the example into 2,000, you can use the rule of 72.
The rule of 72 consists of dividing the interest rate generated by your investments by 72 to find out how many years it would take to double your capital. For example:
If the interest on your capital is 6%: 72/6 = 12 years, If it is 8%: 72/8 = 9 years, or if you have a rate of 10%, it will take 7.2 years.
In conclusion, the key to turning pennies into millions lies in taking advantage of the magic of compound interest along with your long-term vision.
Money is an asset that is too difficult to obtain, and many times we think that by avoiding buying expensive things, we are taking care of it. Unfortunately, we continue with the unnecessary expenses that impoverish us without realizing it.
So, it’s not just about stopping spending money and saving it, but you have to make long-term investments that put money to work for you.
As for coffee, you will be able to continue drinking it from time to time, you will enjoy it much more and if you decide to actively invest this money, you will be building your wealth.