The experts and commentators rave in awe of its power. They extol its benefits while pointing to a hockey shaped graph depicting exponential growth of your small investment becoming a massive fortune over time.
No doubt you have heard all about compound interest, BUT ITS NOT THE SECRET.
No doubt you have heard the quote attributed to Einstein,
“The most powerful force in the Universe is Compound Interest.”
While there is controversy about whether or not Einstein can truly be credited with the quote, what is true is that Compound Interest IS a phenomenon of extreme power.
Why then, do so few people actually harness it? It is a powerful force; there is no question about it. But, that’s not a secret at all. And, that’s not the reason the year 10 Maths Teacher who taught you about it is still broke.
So, the exponential graph shows us that a small amount invested regularly at a modest interest rate can grow into a massive fortune if we let it. As if we don’t believe such a power exists, the nerds like me open up Excel and do the sums thinking “that’s great, in 50 years I’ll be rich if I start now.”
Then reality sets in. That’s going to take a LOT of time.
“You know what, stuff it – I’m going to enjoy myself now”.
That’s the thought process of millions of individuals. Despite having arguably the most powerful force in the universe at their immediate disposal, they thumb their noses at it and chase the next shiny thing. The need for a quick fix overpowers our better judgement even though we clearly understand the power available to us.
Isn’t it funny how we view time in front of us as so long and regretfully dwell on the time behind us as short?
The point is, telling someone compound interest is the secret is like giving someone a Ferrari and not giving them the keys.
How do we unlock this sleeping giant? Well the answer is simple, it’s simple but it’s not easy. And it certainly isn’t sexy.
DISCIPLINE. Delayed Gratification. Restraint.
The reason there are not more wealthy people is because the concept underpinning long term wealth creation is understood and NOT applied.
People know what to do to but they simply do not do it.
So many smart people and yet they are not harnessing this power. Why?
Well, it’s one thing to understand something intellectually – just understanding though will make you smart but you’ll be smart and poor.
We need to make a conscious decision to apply the power with the understanding it will take time to build momentum. Sounds easy right? WRONG – it’s not easy at all and there is a very good reason it’s a lot easier said than done.
Author, Dan Ariely sums it up beautifully in his book, Predictably Irrational – The Hidden Forces that Shape our Decisions, when he says:
“Standard economics assumes that we are rational… But, as the results presented in this book (and others) show, we are far less rational in our decision making… Our irrational behaviors are neither random nor senseless- they are systematic and predictable. We all make the same types of mistakes over and over, because of the basic wiring of our brains.”
In other words, it’s because we are human. Our human psychology prevents us from acting even though we know for sure it’s the intelligent thing to do.
As humans, we like short term benefits. We don’t like the idea of delaying gratification even if it means a massive benefit in the future. We are compelled to chase a quick buck and a cheap thrill.
The secret is not the power of compound interest but rather applying it in a way that does not conflict with your hardwired tendency to seek short term gratification at the expense of long term security and prosperity.
Anthony Moncada (MAppFin, BInfTech, DFS(FP), CertIV FMB), is Director of Wealth Strategic – a Financial Planning Practice specialising in helping Business Owners, Professionals & Proactive Wealth Builders.
Anthony Moncada ( AR 1234994) and Assurance Alliance Pty Ltd trading as Wealth Strategic (CAR 1234995) and Authorised Representatives of Dover Financial Advisers Pty Ltd AFSL 307248.
General Advice Warning – All strategies and information provided are general advice only which does not take into consideration any of your personal circumstances. Please seek personal financial and taxation advice prior to acting on this information.