The Magic of Compound Interest

today i'm going to explain the principle that allows everyday people to become millionaires and build generational wealth this is a straightforward concept called compound interest albert einstein is reputed to say the strongest force in the universe is compound interest he who understands it earns it he who doesn't pays it so throughout this video i'm going to explain the magic of compounding give examples of it at work and show how you can use its power to create wealth but first my name is zach and you should leave a like and subscribe to the channel if you enjoy the video so what is compound interest it's the process in which an asset's earnings from either interest capital gains or dividends are reinvested in order to generate additional earnings over time this creates exponential growth as the investment will generate earnings from both its initial principal and all the previously accumulated earnings the best way to visualize this is as a snowball rolling down a hill it may start small but as it rolls it picks up more snow making it even larger allowing it to pick up even more snow eventually growing the snowball to a significant size this is the same with investing the larger amount invested the more earning power it will generate which you can reinvest to increase earning power even more and so on this fact shows why staying invested and reinvesting earnings is crucial to see the exponential growth from compounding however the most important factor is time in fact the compounding effect gets far more extreme the longer you can keep it going the ultimate example of this is warren buffett's investing career at the age of 90 he has amassed a net worth of 100 billion dollars interestingly over 99 of his worth came after the age of 55. if you look at a graph of his net worth over time it grows exponentially with the most significant gains in the later years his life is practically a case study of compound interest and he attributes his success to understanding this principle at a young age time is everything when it comes to compounding that's why you should start investing as early as you can but even if you're older the important thing is to just start so the snowball can get rolling so where do you begin what about a savings account although this may be better than spending all your money it's actually a terrible way to practice compounding it offers a risk-free way to earn small amounts of interest but your money would actually be losing value over time this is because inflation eats away at your purchasing power faster than it's growing from interest the annual inflation rate is around two percent and you need to remember that inflation compounds as well so rule number one is that you need to beat inflation the best way to do this is to invest in productive assets this is something with the ability to generate profits and cash flow such as a business farm real estate etc well what if you know nothing about investing and don't want to become the next warren buffett lucky for you the s p 500 is an index fund that includes 500 of the largest public companies in the united states this is an easy way to buy a slice of american business and it actually provides great returns there are multiple levels of compounding here some companies pay out dividends which is a portion of their income they give back to shareholders when you reinvest these dividends this is called the total return in comparison to the pure price return dividend reinvestment will help increase the compounding effect also companies will retain their earnings which they use to invest in their business hoping to increase future cash flow this is a form of internal compounding within each company companies will also perform share buybacks which increases the relative value of each share owned all this along with the organic growth of businesses are what creates the compounding effect of investing in stocks if you invested just one dollar in the s p 500 on january 1st 1970 the total return value would be 182 dollars and six cents by 2020. you can see that the rate of growth increased dramatically in the later years this is the compounding effect at work you can just imagine the crazy value created if you invested larger amounts of money or invested consistently throughout so how would an investment in the s p 500 perform today well let's do some calculations to build this model i'm going to take the historical statistics of the s p 500 and project them forward over the next 35 years i took the current price current annual dividend compound annual growth rate of the dividend and a conservative estimate for the compound annual growth rate of the stock price first let's look at how one-time investment of one thousand dollars will perform over 35 years in the end we have a total value of sixteen thousand seven hundred twenty one dollars when reinvesting dividends and eleven thousand four hundred thirty seven dollars when not reinvesting dividends even though the s p 500 has a small dividend yield it still plays a significant role in the compounding effect there is a 46.2 percent increase in total value when reinvesting dividends the rate of growth is growing exponentially in the later years and so is the gap between reinvesting and not reinvesting so again the longer you can compound the greater your results will be let's see what the results would be with a more consistent investing strategy what if you invested 1 000 every month for 35 years in the end we have a total value of 2.3 million dollars when reinvesting dividends and 1.8 million dollars when not reinvesting dividends there is a 27.8 increase in total value when reinvesting dividends the gap is smaller because many of your investments are later and haven't had as much time to let the dividends compound overall this seems like a simple way to retire a multi-millionaire you don't even need to learn anything about investing other than the fact that you need to do it next i'm going to share the powerful compounding effect of my favorite investing strategy dividend investing but first a word from our sponsor this video is sponsored by datacamp as much as i love talking about investing you won't have the capital necessary unless you can scale your income to do this you must increase your skill set datacamp is an online learning platform that makes it easy to build data analytical skills they offer courses for all different experience levels from excel 101 to advanced python r and sql i've actually been a user of data camp for a long time recently i took a course called building web applications with shinee and r this is helping me build more tools for the channel and some web apps that i may share down the line you can start a new career or advance in your field by following career tracks hand-picked by industry experts subscriptions start at 25 a month for unlimited access to courses and there's no credit card required at sign up invest in yourself use my link in the description and check out the first chapter of any course for free now let's get back to the video i practice a dividend investing strategy by investing in high quality companies that consistently increase their dividend payouts for long periods of time this can be companies like coca-cola 3m procter gamble apple microsoft etc the main reason why i like this strategy is that it provides the ability to create cash flow without selling your position in a stock also the yield can be much higher than the s p 500 which has fewer dividend payers and is prone to more dividend cuts this strategy creates a large compounding effect when dividends are being reinvested all right enough talk let's see it at work i'm going to use a model of kmb stock which is a consistent dividend payer and one of my newer investments i'll input the statistics from my time of purchase the price annual dividend keger of the dividend kager of the stock price which you can see here then i'll project this forward over 35 years first let's look at how a one-time investment of one thousand dollars will perform in the end the total value is 25 166 dollars when you reinvest dividends and 9616 dollars when you don't reinvest this is a 161.71 increase all from reinvesting dividends it's a much larger percentage increase compared to the s p 500 example because the dividend yield is higher and thus plays a larger role in the compounding the reasoning for this is you're buying more shares of the stock with your dividend which increases your next dividend payout increasing the number of shares you can buy next thus increasing your payouts even more creating a snowball effect that compounds over time at this point you can continue reinvesting your dividends and see even more massive growth than before or start taking out the payment even if you stop reinvesting your payout will continue to grow as the dividend itself is increased over time if you invest one thousand dollars every month you'll have a total value of 3.1 million dollars when reinvesting dividends and 1.6 million dollars when not reinvesting this is a 93.75 increase in total value from reinvesting dividends again it's lower in this example because many of your newer purchases have not had the time to compound after 35 years of reinvesting you'd be receiving 65 000 a year in dividends which is a 15.6 return on your money invested this fact is why i love a dividend investing strategy you are generating significant cash flow without having to sell any of your stock even if you took out the dividend to pay for expenses you'd still have dividend raises and the internal compounding effect of owning the company it's important to remember that your results may vary due to business conditions and taxation luckily if you invest in a roth ira then you can shield your investment from taxes i hope this video inspired you to start investing and let that money snowball start rolling this idea of compounding is what my channel is all about so subscribe if you want to follow as i build my portfolio and share investing knowledge along the way if you follow me on twitter link in the description you can get real-time updates of my buys and dividends coming in also you can follow me on instagram at dividend data you can support the channel over on patreon where you can gain access to a community discord server the link is in the description please leave a comment below and thank you for watching

Channel: Dividend Data

Views: 134,553

Keywords: the magic of compounding, the magic of compounding | dividend investing, the magic of compound interest, the power of dividend investing, the snowball effect, dividend investing, compound interest, power of compound interest, power of compounding, compounding interest, visualizing long term investing, dividend growth investing 2021, dividend investing strategy, why you need to invest, long term investing, investing for beginners 2021, the power of dividends, dividend stocks

Id: mg30bKeHrgk

Length: 9min 58sec (598 seconds)

Published: Sat Apr 17 2021