As a fun way to learn about compound interest, let's examine a few different ways to become a millionaire. First we'll look at a couple of investors and how they have chosen to accumulate $1 million.
1. Jack saves $25,000 per year for 40 years.
2. Jeff starts with $1 and doubles his money each year for 20 years.
While most would love to be able to save $25,000 every year like Jack, this is too difficult for most of us. If we earn an average of $50,000 per year, we would have to save 50% of our salary!
In the second example, Jeff uses compound interest, invests only $1, and earns 100% on his money for 20 consecutive years. The magic of compound interest has made it easy for Jeff to earn his $1 million and to do it in only half the time as Jack. However, Jeff's example is also a little unrealistic since very few investments can earn 100% in any given year, much less for 20 consecutive years.
TIP: A simple way to know the time it takes for money to double is to use the rule of 72. For example, if you wanted to know how many years it would take for an investment earning 12% to double, simply divide 72 by 12, and the answer would be approximately six years. The reverse is also true. If you wanted to know what interest rate you would have to earn to double your money in five years, then divide 72 by five, and the answer is about 15%.
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