The Magic of Compound Interest
“Compound interest is the Eighth Wonder of the World. He who understands it, earns it. He who doesn’t — pays it.” —Albert Einstein
The beauty of compound interest is, it allows you to earn interest on your interest — it allows your money to work for you, instead of the other way around.
In this edition of the Great Investor Newsletter, I would very much like to impress upon you the extreme value of compound interest.
As an example, here is the growth of $10,000 at 8%[*] compounded annually:
TIME ENDING VALUE GAIN
1 year $10,800 $ 800
5 years $14,693 $ 4,693
10 years $21,589 $11,589
Please notice, focus, dwell, and pay attention to the value at the end of 10 years. There is a gain of $11,589 — your original investment has more than doubled!
My question is, how much did this investor have to work to make $11,589? The answer is — naught. I cannot emphasize enough the importance of compound interest — the higher the investment return, the more profound the outcome.
Most people think a few extra percentage points of interest doesn’t amount to much money. Not so! Understanding the value of compound interest is key to achieving financial freedom. The following chart shows what happens if you invest $100 per month at 5%, 8%, and 12% for 40 years (the amount of years we typically work):
Get the point? By receiving a hypothetical 12%** rate of return vs. 5%, you don’t end up with 7% more money. In this case, it’s 700% more money. It pays to invest wisely.
One final example before math anxiety sets in:
If you were given a choice to receive one million dollars in one month or a penny doubled every day for 30 days, which one would you choose? If you took the million, unfortunately, you missed out on an additional $4,368,709.12!!!
Your penny doubled every day for a month is worth $5,368,709.
DAY AMOUNT DAY AMOUNT
1 $ .01 16 $ 327.68
2 $ .02 17 $ 655.36
3 $ .04 18 $ 1,310.72
4 $ .08 19 $ 2,621.44
5 $ .16 20 $ 5,242.88
6 $ .32 21 $ 10,485.76
7 $ .64 22 $ 20,971.52
8 $ 1.28 23 $ 41,943.04
9 $ 2.56 24 $ 83,386.08
10 $ 5.12 25 $ 167,772/16
11 $ 10.24 26 $ 335,544.32
12 $ 20.48 27 $ 671,088.64
13 $ 40.96 28 $1,342,177.28
14 $ 81.92 29 $2,684,354.56
15 $163.84 30 $5,368,709.12
Big difference between $1 million and $5.3 million, huh?
I don’t know about you, but this makes me want to start saving my pennies, nickels, and dollars.
I sincerely hope these illustrations will help you appreciate the magic of compound interest. I urge you to get it working for you as soon as possible.
If you would like to learn more about how you can become a better investor, pick up a copy of my latest book, How to Be a Great Investor – Investment Techniques for Christians. It’s available on Amazon, in paperback and Kindle version. You can also order it on GreatInvestor.org.
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Here’s a final thought from the greatest investor of all time:
“My wealth has come from a combination of living in America, some lucky genes, and compound interest.” —Warren Buffett
Thanks, and Blessings,
Richard Everett
[*] An assumed rate of return, for illustrative purposes only. The S&P 500 has a 60-year average annual return of roughly 8%.
** There are mutual funds with 12% average annual returns for 50 years and longer.