PassiveEarning

Compound Interest in Investing

Lately I have been thinking about why did I start this journey and how I can help other persons realize that they could do more with the money that they have.

Why Invest?

Why should you invest? Because you can make your life better. Investing is a way to make more money, and money can give you the freedom to do what you want and not to do what someone else wants. Imagine that you have a rental property that generates 250 € per month after all costs and that your job pays you 25 € per hour. This means that every month you can work 10h less and get the same amount of money for all of your activities. Now try to scale that idea, you have 3 properties ( combination of apartments, garages, parking lots and other things), these 3 properties generate 750 € per month, so this means you can work almost one week less every month.

Would it be nice to spend more time on yourself and your friends and family than to work in a company from 9 to 17? Of course it would!!!

One method where you can reach that level is compounding. What if you invest the 250 € that you earn from a property into buying another property. You could take a credit loan, where your monthly rate is 500 €. Two properties earn you 500 € per month, so this means that your properties pay for the loan. After the loan is paid off, you can buy another property and use three properties to pay off the new loan. With three properties you can pay off the loan much quicker because you can pay off 750 € per month.

This is the basic principle of compounding and compound interest. You leverage existing income sources to generate more income sources. But let us describe compound interest more formally.

What is compound interest?

Now let me introduce the concept of compound interest, according to some sources, the concept originated in 17th century Italy. Compound interest is “interest on interest” and it will make your investment value grow in a faster rate then simple interest. Since we are talking about simple interest, let me expain the concept of simple interest first.

Simple interest is a fast and simple method of calculating the interest charge on a loan. It is calculated by multiplying the daily interest rate by the principal by the number of days that pass between payments. Where the principal is the original value of the loan.

Now let us explain what is compound interest and how you can use it in your investment calculations. I will mostly focus on stock investments. The following formula given below will help you calculate the amount. In the given formula, the principal amount is also given with compound interest included in it.

In order to understand this let us tackle a simple assignment, if we invest 5000 € in a specific asset (let us think in some stock) over 10 years with a annual return of 5% and each month we add 100 Euros to the same asset, we would have 23992.618 Euros at the end. Bellow you can see a simple compound interest calculator. Since the world is not fair and we all have to pay tax, I also included the tax as a parameter of the calculator. The idea is that you want to take the money that you earned at some point in time and if that moment you have a tax rate. If we would take the 23992.618 Euros out after 10 years with a tax rate of 10%, we would have to pay 699.262 Euros in taxes at that point, since you have earned 6992.618 Euros until that point. But this is specific for every country.

Try tweaking the parmeters to see how much you would gain.





Looking at the table and graphs above it is visible that after a certain period, the compound interest method starts producing more and more money. At some point, the initial 100 Euros that you invest every month starts being covered by the interest payout. This is why you do not notice improvements at the start of your investing career, but after some time, you notice that even small changes in your portfolio can produce noticeable amounts of money. Speaking of portfolio, if you want to create your own portfolio of stocks, you can use the portofolio Link to see your stocks and the stocks Link to add stocks to your portfolio.
When you have stocks in your portfolio you can get additional information about your stocks via the portofolio page.

Conclusion?

Looking at the simple concepts of the compound interest investing we can see how much we can earn if we simply reinvest the money that we earn from our investments. When we reach a point that our investments generate a certain amount of money, for me it would be 1000 Euros per month, I would stop my reinvestments. Imagine earning 12000 Euros per year for simply holding an asset.

It is also important to know when to stop reinvesting and not be greedy.


For now, I do all of my trading via eToro and you can read about that in here. If you are interested in finding out more about investing, I can suggest this --> The Intelligent Investor.
Disclaimer:
This is not financial advice.
I am not a financial advisor.
The intention of the post is just to share my experiences.
eToro Disclaimer : "66% of Retail CFD Accounts Lose Money

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