I have discussed the miracle of compounding interest before in regards to individuals and to whole civilizations. It is an important concept to learn when you are young. You can benefit a great deal from understanding the power of compounding interest. Those who don’t grasp the concept are bound to make bad decisions in life.
Compounding interest applies to other things aside from your individual investments. While there may not be any numbers associated with this, compounding interest often occurs with learning. It can also occur with starting a business or with taking up a hobby.
The whole concept could apply, at least in a sense, to someone learning how to surf. The person might be really bad the first time he goes out in the ocean with a board. It may take many times going out there before he ever catches his first wave. But as he practices and puts his time in, he slowly gets better and better. It is no coincidence that many of the great athletes in this world started when they were young.
Back to the idea of investing, is compounding interest still beneficial in an environment of low interest rates? Currently, putting money in a cd or a savings account in the bank will barely make any interest. In fact, if you factor in price inflation, you are probably losing money.
But I ask, what is the alternative? Are you better off going into debt? Are you better off having little or no savings?
Another thing to consider is that interest rates will not always remain low. If and when rates go up, you don’t want to be in a position where you are heavily indebted, especially if the rate is not fixed. Imagine having credit card debt or some other variable rate loan.
On the other hand, if and when rates go up, having money set aside will be beneficial. You can start earning those higher rates of return instead of paying them to creditors.
Of course, an important point is that you don’t have to put your money in the bank. You can put it in a setup like the permanent portfolio as described in Harry Browne’s book Fail-Safe Investing.
I am also a big fan of real estate, especially in the post-bubble world. Mortgage rates are incredibly low and you can find some real bargains in many parts of the U.S. Many people are finding they can buy a place and get a return of 10% or more from the rent. In addition, they are getting their mortgage amount paid down each month. This in itself is a form of compounding interest.
In conclusion, just because we are currently in a low interest rate environment, it doesn’t mean that you shouldn’t save money. While it is harder to get ahead, it is not impossible. And you are better off saving a little than nothing at all. When rates do go up, you will be better off with savings. If it is in a highly inflationary environment, you can buy hard assets to protect yourself. So while compounding interest may not seem to be beneficial right now, it can still work miracles for us over time, whether it is with your money or learning a new skill.