The power of compound interest is one of the key aspects of building wealth. It underpins all of long-term investing. When $100 earns a 10% return, it grows by $10 to $110. Next time it earns 10%, it earns $11, not $10. And this effect snowballs as the investment grows year over year. There are relatively complicated formulae to show how money compounds, yet there is a simple method to think about compound interest: the Rule of 72.

Divide the number 72 by the rate of return to get the time in years to double the investment money. The concept was made famous by Albert Einstein, who touted that "compound interest is the eighth wonder of the world." Assume we earn 4% on our investment. 72 divided by 4% gives us 18 years. Say we earn a $10,000 bonus from our job. Instead of using it to finance a BMW or Mercedes, we can invest that $10,000 at age 29, and when we retire at 65, we will have $40,000.

How about 6%? We double more often and end up with $80,000 at retirement. At 8%, we have $160,000 at age 65. Do we see the power of compound interest? At 12% interest, by 65, we would have $640,000. Which do you prefer to end up with: $40,000 or $640,000? The one with more money right? This is why I decided to sell my BMW and invest, so I can have more peace of mind later.

Do we see how important it is to invest earlier than later? Looking at the 12% example, what if, instead of starting at age 29, I started at age 35? Now, I need to wait until age 71, not age 65, to hit that $640,000 mark. Meanwhile, the person who started investing at 29, how much would there be by age 71? Over a million right? What are some challenges to building this kind of wealth? This topic needs its own dedicated post, yet one reason may be that compound interest's impact hits hardest later, sometimes much later. We all have a choice: invest and delay gratification now, or spend any excess cash we have now and live it up. That $10,000 growing to one million seems far off versus whatever product we see in front of us at the store or online.

Another consideration: let's say we were so diligent investing our money. We held off buying our nice car or Hermes bag. We waited in line at Costco gas station and bought everything on sale, so we can grow our money to that $640,000. The market has been good to us. But, how would we feel if we lost $200,000 or even $300,000 of that money when we cash out? Doesn't feel too good, right? The source of this loss? Investment capital gains. This is why we must understand another fundamental principle: tax strategy.

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