Compound Interest is the Eighth Wonder of the World
What is the Eighth Wonder of the World? Well, according to Albert Einstein, compound interest is the Eighth Wonder of the World. “He who understands it earns it, and he who does not pays it.” Today we’re going to go through what this statement means and just how incredibly powerful understanding this can be in your life.
If Albert Einstein, a pretty smart dude, said compound interest is the Eighth Wonder of the World, I think we should all listen to why it is. And see, we’ve all heard about compound interest. We know what interest is, we know how people talk about, “Well, when you save money, it makes money.”
But today I’m going to put some shocking numbers in front of you, where even if you’re really good at math, the numbers will blow you away. Even if you’re not that great at math, man, they’re really going to blow you away because it just doesn’t seem to make sense.
Our brains cannot possibly comprehend this. And so to start with, the example I’m going to give you is this. This will explain to you what compound interest is like.
An Example of Compound Interest in Action
I don’t know how many of you play golf out there. I’m a pretty terrible golfer. But let’s say you’re a pretty good golfer and you’re going to go golfing with a friend and you want to have some fun with this friend, right? So you get out to the golf course and you know you’re better than they are.
(And you make sure you know you’re better before you do this. Otherwise, it’s not going to be a good day for you.)
But you tell your friend, “Hey, you know, I kind of feel like putting some money on this game, make it a little more interesting. What do you think?” And the friend says, “Yeah, yeah. That sounds like a good idea. How much do you want to put per hole?” You’re like, “Whatever.
What do you think?” The friend says, “Why don’t we just do $5 a hole.” Okay, and you look at him and you’re like, “You know what? That’s good, but here’s the thing, man. My golf game, I always start off really slow, so why don’t we just make it where the first hole, let’s do 25 cents.
I know you want to do $5, so what we’ll do is every hole, we’ll just double it. Okay? So we’ll start off with 25 cents the first hole, the second hole will be 50 cents, the third one will be a dollar, and so on and so forth. We’ll just double it each time and towards the end, it’ll be a little more exciting.”
And the friend thinks about it and goes, “Okay, yeah. That sounds great.” Understanding compound interest works as follows. So at $5 a hole, 18 holes of golf, that would be $90, right? The total bet would be $90. Let’s see what happens if instead of that we start with 25 cents – a much lower amount – and go forward. So the first hole will be 25 cents. The second hole will be 50 cents. By the sixth hole, it gets to $8, right?
Still not much; that’s not a big deal. Eight dollars a hole, a little more than your friend wanted to spend per hole, but at this point it’s still not that big of a deal because the first few holes were way, way, way less, right?
By the ninth hole, you are now betting $64 a hole, which is definitely more than your friend wanted to bet per hole.
So it’s $64 a hole and you’re almost near what you would have spent the entire 18 holes, and your friend is getting a little scared here. He’s like, “Oh gosh, you know, that’s more than I wanted to spend. But it’s no big deal.” He’s perfectly fine.
By the twelfth hole, you are now betting $512 per hole, and at this point, your friend is looking in his wallet and saying, “Ooh, I didn’t bring enough money for this.” But he’s still thinking about it and he’s going, “Man, this is crazy — $512 a hole. You pulled a real fast one on me! Thank goodness there aren’t that many holes left.” You get to the sixteenth hole and you are now betting per hole $8,192.
So by the sixteenth hole you’ve gone from 25 cents to $8,000 a hole. By the eighteenth hole my friends, the bet is $32,768. That’s cents doubled 18 times, and it comes to the last bet being $32,000 and some change for a total bet – remember, at $5 a hole, the total bet for 18 holes would have been $90. Ninety measly dollars.
And when I started this, all of you knew, “Ooh, Arman is going to talk about this number,” and you thought it was going to be a big number when I said it. But how many of you thought it would go from $90 to listen to this total — $65,535.75 – and we started at a quarter.
Compound Interest is the Secret to Making More Money
So my friends, the next time you want to make more money, you want to have more money, you want to have more wealth, it’s not about going to your boss and asking your boss to give you a pay raise. That pay raise is the equivalent of winning another $5 hole, right? Instead, if you can figure out how to get compound interest to work for you, the power of it is incredible.
So how does understanding compound interest apply to you? See, when you’re borrowing money, you are on the wrong end of compound interest and you’re paying it. And yes, you’re paying it at these kinds of rates.
So if I take you to the golf course and I tell you to play this game with me, unless you know you’re better than me, you’re probably not going to take this bet. But we take this bet every day with our credit cards. We take this bet every day when we go into debt.
Now, if you understand this and you put your money into what? What did I talk about last time? Assets, not liabilities. If you put your money into assets, guess what? You earn money at this rate. So I have a simple Titanium 7-Year Rule that assumes you can put your money into something and make about a 10% return.
When is Compound Interest Used? – The Titanium 7-Year Rule
Now look, 10%, some of you are going to say, “Well, that’s pretty high.” It’s really not that high. If you look at the average real estate investment over the last 25 years – and I say 25 years because it includes the massive drop that we had in the mid-2000s, okay?
If you look at real estate then over the last 25 years, making 10% on your money would have actually been quite easy. And part of the reason is this – it’s not like you have to go buy a house with cash, correct?
So let’s take a simple example of a house and let’s use a simple number that’s easy to do for math. Let’s say you buy a house for $100,000. If you buy a house for $100,000, you’re typically not buying it cash. Let’s say you put $20,000 down on that house, so your true investment is only $20,000.
How to Calculate Compounding Interest
So now let’s say over the period of some years, that house goes up from $100,000 to $110,000. I ask this question to rooms of hundreds of people and you’d be amazed that over 80% of people get the answer to this question wrong. Well, if the value of your house goes from $100,000 to $110,000, what percent have you made?
Most people will say I’ve made 10%. You have not. You have actually made 50%. Why? Because your original investment was only $20,000. So if you sell the house today, you’re actually going to be able to pay back the loan and you get to keep $30,000, taking all the transaction fees and stuff like that out of it – let’s ignore all that. You’ve actually made $50,000.
So imagine what happens if your house goes up in value, let’s say $20,000. Now that you’ve made 100% on your money.
What if your house doubles in value? If your house doubles in value from $100,000 to $200,000 – and by the way, any of you who live in Southern California or various parts of the US, you’ve seen this happen over the last seven years, where some real estate values have literally doubled. It’s the key to understanding compound interest.
And so during that time, think about it. If you had bought a house for $100,000 and you put $20,000 into it, and now the house is worth $200,000, you have actually multiplied your money by a factor of six.
That’s 600% growth in eight years. So my friends, when I ask you for 10% a year in interest, can you earn 10% on your money? Yes, by learning some very simple tools, it is fairly easy to make 10% on your money.
Now, I’m going to talk to you about real estate in a future episode here. I’m going to talk to you about the stock market, but there are so many different ways of investing your money, so today we want to talk about the 7-Year Rule.
The Titanium 7-Year Rule Defined
So what is the 7-Year Rule?
Assuming you can make 10% on your money if you hold off on buying anything for seven years, then seven years from today you can buy that thing that you held off on and still get to keep your money.
Interesting. What does that mean?
Let’s say you want to go out and buy yourself a nice convertible. You go out and you see this beautiful Mercedes convertible. It’s your dream car and you want to buy it today.
If you buy it today, then you get to have the car and you pay for it. But if instead of buying it today you say, “You know what? I’m going to keep driving my economical car for the next seven years, and in seven years I’m going to go buy that same Mercedes.”
If in seven years you buy that Mercedes – and by the way, you get to get the newest version or whatever it is – assuming it is the same price it was – you now get to keep your money and get the car.
And here’s the best part: you get to keep your money, you get to keep the car, and you’ll get a new Mercedes every seven years for the rest of your life. Yes, that’s true. How does that work? Well, let’s say the car that you’re going to buy is $100,000 and you invest it.
Well, if you’re making 10% on your money, what that means is that your $100,000 in seven years will be $200,000. So now you could take $100,000 of it out, go buy the car, and guess what? Understanding compound interest. You still have your $100,000. But that $100,000 is going to double every seven years, meaning you could get a brand-new car every seven years.
Now by the way, if you can make 15 or 20% on your money, this becomes like the 3-Year Rule or the 4-Year Rule. So the key is by just saying, “Hey, I’m going to wait to acquire this liability,” you get to keep your money, get that thing that you love, but then you get it every seven years for the rest of your life.
It also, by the way, works – let’s say you are going to buy something and you’re going to make payments on it. So if you’re going to buy a car and you’re going to make payments, you don’t have $100,000, but the same rules still apply.
If instead of making the payments of whatever it is, $500 a month if you take that $500 and you invest it into something where you’re making at least 10%, then in seven years you get to have that car for free for the rest of your life. And again, you get to rebuy it.
You a new version every seven years. By the way, I’m not even talking about what you do with the old one. You can sell the old one and get the money from that one as well on top of all of this.
Essentially, if you hold off on something that’s a payment – okay, this is an important one – if you hold off on making that payment for seven years, then your money will build enough to be enough money for you to make that payment every month for the rest of your life and still keep your money. It’s pretty amazing.
Making the Titanium 7-Year Rule Work for You
Now the 7-Year Rule works in one other way, too. Let’s say you invest $100 per month for seven years and then you stop. See, that doesn’t seem like much. Anybody listening to this podcast, even if you are literally working for minimum wage, I guarantee you that you can find $100 somewhere. Anybody listening to this.
If you can afford to listen to a podcast, whatever device you’re using, trust me, you can save $100. What if you saved $100 a month and then stopped after seven years? See, the power of compound interest is such that’s not much money at all. But in 30 years that adds up to be $100,000.
Now when you look at that and you’re like, “Well, what’s the big deal of $100,000 in 30 years?” Look, you’re only saving $100 a month, right?
Well, what if you invested $1,000 a month? See, if you invest $100 a month and then you stop after seven years – that’s the key to this. You stop in seven years and then you do whatever the heck you want. In 30 years you’ll have $1,000,000. That’s insane! The thought that $1,000 a month in investment can turn into $1,000,000 – and again, it’s only for seven years.
So the 7-Year Rule works for you or against you depending on how you do things. So get on the right side of this compound interest thing, start focusing on acquiring assets – things like stocks, things like real estate, businesses, tools – things that make you money.
Get out there and invest in those things instead of purchasing all these liabilities. And all the liabilities that you want, just tell yourself, “I’m going to wait for them.” Now, you don’t have to wait seven years. If you wait three years or three and a half years, hey, you’re halfway there.
So now if you hold off on buying that car for three and a half years, essentially half the car is paid for. Hey, that’s not bad, right? And if you can make more than 10% on your money (which I guarantee you most of you can make way more than 10% on your money) if you’re intelligent, if you do wise things with your money, you could make a lot more.
So get out there, apply the Titanium 7-Year Rule, and understand that Albert Einstein wasn’t kidding around when he said, “Compound interest is the Eighth Wonder of the World. He who understands it earns it. He who does not pays it.” I want to see you guys kick some serious butt with your finances.
So now I’m about halfway through this series on finances. You’ve got some really, really good information, so there are three more episodes coming up, but don’t wait for those three episodes.
Do what I taught you already in the first episode: cut your expenses, number one.
Number two, start acquiring assets and allow the 7-Year Rule to work for you. And then number three, once you’ve done those two and once you’ve learned how to use money, get out there, work as hard as you possibly can, make as much money as you can, and be smart with that money, and of course be obsessed with your long-term goals.
Hey, next time we’re going to come back and we’re going to talk about in the next two episodes investing in real estate and investing in the stock market.
If you don’t know how to do it, I’m going to give you some of the basics or at least some basic motivation for it and some really cool secrets I’ve discovered throughout the years that are going to help you make it a reality and make it a big success.