Original published on Blogcritics.org
Who would pay $500 for a cup of coffee?
No one would, except for a few extremely well heeled Europeans and Russian oligarchs, who sate their palettes with Diamond, an ultra-luxury blend brewed from beans passed through the digestive system of a small Indonesian feline.
So why are you?
Well, if you’re a baby-boomer like me, you’re not, but if you’re 20-something, the future value of one week of gourmet coffee could easily exceed $500. If you invest all your coffee money for just one year, it could be worth tens of thousands of dollars when you retire.
How is this possible?
When you invest, rather than ingest your coffee money, the compounding effect of interest paid on interest can grow small deposits into giant nest eggs over time. The key is patience, because it could take years to see satisfying results and decades to realize appreciable gains.
How does compound interest work?
When you invest $100 at 5% for one year, you earn $5. ($100 x 5% = $5.) Now you have $105. When you reinvest your principle ($100) and interest ($5) for another year, you earn $5.25 ($105 x 5% = $5.25). Every year that you reinvest, you earn more than the year before. In year 30, you’ll earn $20.58 in interest bringing you total investment to $432.
Investing should be like watching paint dry or grass grow. If you want excitement take $800 and go to Vegas.
– Paul Samuelson, Nobel Prize winning economist
Unfortunately, most people, including myself, don’t realize the wealth building effect of compound interest. As a homeowner who paid over $200,000 in interest on my home loan, I saw how banks made money, but as a depositor reviewing my bank statements, I never saw more than a few dollars in earned interest even when I carried a large cash balance. I understood how interest worked for the banks, but not for me.
Then I started working on The $500 Cup of Coffee®, a book I recently completed, which encourages a lifestyle approach to financial independence. Researching the book, I took a close look at the S&P 500, a group of 500 of the largest publicly traded companies in the United States. Had you invested in the S&P at its inception in 1926, and reinvested all your earnings, you would have earned an average annual rate of return of 10.12%. In other words, a $100 investment in 1926 would be worth nearly $870,000 today.
Small amounts can add up to financial independence
Now most of us don’t have a 90-year investment horizon, but if you’re 20 or 30-something and start investing $100/month today, it could be worth a lot when you get ready to retire. Though past performance is no indication of future returns, let’s assume – just for fun — that the market continues on the same trajectory. In 40 years, your $100 monthly investments will be worth over $655,000.
If this seems too good to be true, it probably is. After factoring in safe investment strategies, management fees, income taxes, and inflation, 6.0-6.5% is a more reasonable rate of return. But even at that, your investment increases in value four to five times.
The moral of the story is simple: consistent investing of small amounts can yield substantial returns over time. This is good news for everyone, because you don’t have to be born rich or make a lot of money to achieve your goal of financial independence. Anyone who is young enough and mindful enough can invest their way to a financially secure future one coffee cup at a time – provided they start today.