Some say that Albert Einstein considered compound interest to be the eighth wonder of the world; “He who understands it wins it, and he who ignores it pays for it.”
What does “Compound Interest” refer to?
Let’s say it’s essentially straightforward, and apparently, it’s disappointingly simple; but it is only the interest that the interest can generate, that is all.
What happens is that it lends itself to some situations; for such incredible money growth circumstances that it truly leaves you stumped, and let’s look at some specific examples so that we can understand precisely how it works, how you can leverage it, and how you can use it to grow your money.
Let’s start with a real application case in a genuine industry.
Let’s talk about online businesses, specifically those that focus on sales of digital products.
Suppose I have a product for sale (let’s say it is a course on how to advertise on Facebook or a lesson on cooking or something).
So, I initially have a subscription page with free samples of my content, very similar to what we will have in a physical business, where people simply visit, take a free sample, and see what the product is like, if they like it. or not and then maybe calmly decide whether to take it.
So, in the digital business, I have 1,000, 2,000 or 3,000 visitors on my subscription page; a percentage of those visitors are going to sign up to my website.
From there, I start emailing them, and not everyone I email will open it (they’ll clip it).
Some signed up with the misspelt email; others were just exploring and weren’t really interested; Others received the email and decided they don’t want to clip the link.
Ultimately, I have a portion of people who subscribed but still did not clip; and another portion that did clip and reached the page where I offer my product.
In the same way, a portion of the people who visit my sales page, where I make the offer (I say the price, I show the means of payment, what are the benefits and others), a group decides not to buy, and one A portion of those people decide that they are going to buy at the moment.
My income depends on what is that percentage of people who visited and subscribed ; after that percentage that subscribed, how many made a clip; After those, how many did they buy , and ultimately that is what generates the income for me.
So, we analyze, for example, a case of percentage increase (you will see what I mean by all this particular example, but I want you to be quite clear about it).
Now we will transfer this example to specific figures to understand it better.
Example Of Compound Interest To Improve Your Business
Suppose I have 10,0000 visits to my initial subscription page.
An average conversion rate for a subscription page can be 20%, which means I would have about 2,000 subscribers on average.
Subsequently, I would send a set of emails, any number and any frequency.
A conversion rate for sending emails, from subscribers to clicks (that is to sales page views), could be around 25%.
In other new words, out of the 2,000 subscribers I got by sending 10,000 page views, I now have 500 people who have clicked through the emails and visited my sales page, and of course, my sales page may just not convert to the big one. most people are buyers (and that’s normal); in fact, on average, we can have between 1% and 2% conversion of visitors to buyers.
So, we talk that of these 500 visitors, we have 10 sales.
If the product costs about $ 100, we can say that of these 10,000 initial visitors, and we get $ 1,000 as income.
This is where the interesting thing begins, we are going to increase visits by 20% (only visits and nothing more than visits).
Now, we have gone from having 10,000 visits to having 12,000.
Automatically and with the exact subscriber conversion, we would have 2,400 subscribers, 600 clicks instead of 500, and 12 sales instead of 10; so far everything normal.
But now we will improve the second variable, 20% as well.
So, we are going to increase our subscription conversion by 20% (before, it was 20%, now it is 24%). It means that before of the 12,000 visitors I had, I managed to subscribe 2,400, now I can convert 2,880 into subscribers, keeping the click rate the same at 25% and the sales rate the same.
Anyway, I increased my income by two additional sales.
Now let’s think about increasing clicks by 20%.
The click-through rate is the number of people who subscribed (who are actually clicking on my emails).
As we will increase it by 20%, we go from 25% conversion to 30%.
In this case, out of 2,880 subscribers we had before, 720 clicked, but now with this improved click conversion, 864 of them connect.
It means that those 864 reach the sales page that does keep its conversion rate the same, it generates 17 sales.
Lastly, we will improve our sales page by 20% as well.
Note that we have an increase of 20% in each of the steps, so things would have the same 12,000 visits, the same 2,800 subscribers, the same 864 clicks; But now the sales conversion rate is not 2% but 2.4 (because we increased it by 20%).
Notice that having improved visitors by 20%, subscribers by 20%, clicks by 20% and sales by 20%, we doubled our income.
Apparently, the improvement was 80%, but the reality is that it was 100%.
This is the power of compound interest because as you can imagine when I increase visits, all other variables will be affected.
That is, the absolute number of subscribers, the absolute number of clicks and the absolute number of sales also increased; the same is true for all other variables.
It means that if I have a digital business with this same model, I could dedicate myself solely and exclusively to increasing visits for three months and, nothing more than increasing visits by 20%.
I don’t have to think about doubling my income, just increasing visits by 20% for three full months.
Later, the other months I dedicated myself to improving the emails to increase the number of clicks; I try different issues, different links and just by working on that 20% I already have half the work done and, so I can continue working for half the rest of the year until at the end I double my income in this is a case.
You always see examples of Compound Interest in investments, returns, debts, and things that are suddenly a little more normal, but I want to show you that we can implement it even in our businesses.
Let’s see how Compound Interest works in investment and savings issues.
Example Of Compound Interest In Investment
Suppose we have an investment fund that we open with initial capital and begin making certain additions to it.
Suppose that at the beginning, we are not going to add any amount of money at any time and, we are only going to depend on the money that the investment fund generates by itself for a certain amount of time.
So, we are going to assume an interest rate of 10% (this is the return that this investment can generate).
For a simple example, let’s start with a base, say $ 1,000.
We start with $ 1,000 as a base and clearly with an interest rate of 10% …
The first year we will have a profit, interest of $ 100 (which is 10% of $ 1,000); in that year, we would have a total of $ 1,100.
If I were to make a linear profit calculation on the same basis of $ 1,000, that generating 10% per year then in the first calculation gives $ 100 … I would assume that at the end of 10 years with that investment, I could have $ 1,000 profit.
That would be a linear calculation without compound interest.
But that is not how investments work in this case.
For the second year, leaving the first year with $ 1,100 invested (which was $ 1,000 base and $ 100 of interest gain), at the end of the second year I would be left with $ 1,210.
Why? Because now it is no longer $ 1,000 that is bearing interest, but it is $ 1,100.
In other words, this $ 100 that I earned the first year, earns $ 10 of interest for the second year (keeping the same 10% gain in interest).
As we can see, from then on the interest generated each year (although it may not seem like it at the beginning) is really exponential.
Here we can see how really (even without adding any capital), only if I make an investment there and make a long-term investment, assuming an interest rate of 10% (we will also talk about rates), I can grow my money much more than it seems.
If you invested your savings for retirement (for the pension), in an investment fund that generates you, let’s not say 10% that suddenly is not so simple and easy to get today; but 7%, to make some accounts a little more conservative.
We have an initial deposit, (let’s talk about it being about $ 100) and, that every month I will add $ 100 to this investment fund.
It means that every month I am increasing the total capital that there is, therefore the Compound Interest is increasing; as much of what I am saving, as what is generating interest.
We are going from an estimated base of 7% return on annual effective profitability and we are going to place the time (in this case in a year). So it would just be $ 1,300 that I start with and $ 54 of interest; but we are going to expand it and we are going to see how it would be, for example, in the first ten years.
On the one hand, I would have in the capital that I contributed, $ 100 opening and $ 12,000 (which was $ 100 for 120 months). On the other new hand, in this case, the 7% Compound Interest generated a return of $ 5,512, which means that in total, I have $ 17,512 in my capital.
If I could save thirty years (assuming that I had not started saving at thirty; I realized the value of doing so and did it until I was 60 years old) … We are saying that I opened the account with $ 100 and invested $ 36,000, that says $ 100 for 360 months, and we see an interest-only return of $ 87,000 for a total of $ 123,500.
Imagine a person who can save for forty years (because he started doing it at age 20 and wants to retire at age 60). Then, think about the incredible increase, how many times the initial capital multiplied only by Compound Interest.
For that reason, I always recommend these retirement savings; And the sooner you start it, the better it will be for you.
Of course, when we talk about the profitability of 7%, 8%, 10%, we do not mean that it is a constant thing.
Some people ask me” Who can pay me a Compound Interest of 10% ?”; « Who pays me to 7%? «. No company says: « Give me money and I pay you 7%, guaranteed 100% stable, constant and fixed every month » It does not exist.
There are investment funds; investments in fixed income, stocks or variable income, government bonds, private companies, real estate; the number of things that can be used; investment mechanisms and vehicles, whose profitability will change over time.
This is where we talk about risk, but many people when they hear the word “risk” think of losses.
This can be true, let’s say with some cryptocurrencies for example that have gone to the ground, immediately after starting or after achieving some very high value; they are bubbles that eventually burst and either reach a value close to zero or lose all of their value.
Other investments that can be of moderate risk or high risk, during a long-term period generate consistent positive returns; An example of this is the SMP5100, which is an index that follows the 500 most valued companies in the United States, which has generated an average of 10% effective annual profitability during the last 90 years.
In the graph you can see how the trend is constant upwards.
However, there have also been moments of losses (there are ups and downs, it’s like a roller coaster).
Basically, if a person opens the fund at the peak of these that we have there and begins to analyze how his money moves ?; What is the value of your money in the short term and into the medium term ?; You will realize that your money may even be decreasing in value, that is my risk tolerance; how much I can control “not freaking out” if I see that the total value of my savings may decrease.
Why? Because if I wait a while and, I am really for the game, it is for the long term, I can see positive profitability, as practically anyone who has done it for some time of at least 20 years is going to see that return.
In other words, a person who has invested in any period of 20 years in the fund of SMPS100 has seen profits yes or yes.
All of this is for you to really think about how you too can invest your savings.
People, who ask me: Invest or save?
Better yet, make money grow than after saving; after you simply have your expenses; You have control over your finances, but you also guarantee your future.
You leave a portion of what you earn for the short term (for your tastes, for your luxuries, for your fun, for your entertainment). Still, you also leave a portion to think about how to multiply it through a highly scalable mechanism, such as Compound Interest investments, which we can find in a mandatory investment fund, for example in the Individual Regime (in Colombia one can save in the Regime Individual and invest in low, moderate or high risk); in Voluntary Pension Fund (which works very similar, only without so many costs and, without the solidarity expense that the Mandatory Pension Fund has, or else it is with tax benefits issues and it is money after-tax).
I can look for a private investment fund, with Banks or with entities or with cooperatives.
Rather, I can find options everywhere; it will depend on the country, the profitability; It will depend on the moment, in what you are investing; If you invest in dollars, if you invest in pesos; if it is fixed, if it is variable income.
We have to educate ourselves and understand how it works, but the most important thing is to start as soon as possible so that we can take advantage of the true potential that our money has.
Now, think of a case as simple as this.
In the example we saw, where we invested $ 36,100 and we had more than $ 123,000 at the end of the year; we are talking about every dollar invested.
Actually, in the end, they were worth more than three times what I put in.
This puts me in perspective that if I want to buy an iPhone that is worth $ 1,000 today, it is almost as if it were really costing me $ 3,500; because that is the potential that I am losing to save, invest, grow and multiply my money, with which I understand and begin to improve my decision making and to say “YES, this is a good decision, I see the value in it; This cell phone can generate much more than that money in the short term” or “NO, perhaps this is not a good decision and the cell phone is not going to generate any productivity and, on the contrary, it will distract me from my goals”.
It will depend on each person, but it gives me a strategy and a clear tool for me to make decisions.