It’s been rumored that Einstein said the most powerful force is compounding [interest].
Simply put, compound interest is interest calculated on not only your initial principal but on any accumulated interest as well.
Jack invests $10,000 and earns 7% interest per year.
Year 1: Starting amount = $10,000. Interest =.07 * 10,000 = $700. New balance = $10,700.
Year 2: Starting amount = $10,700. Interest = .07 * 10700 = $749. New balance = $11,449.
Notice that in year 2 that you earned $49 more in interest than in the first year. This is because you earned interest on top of the interest that you had already earned. The extra $700 produced in the first year earned you that extra $49. This amount just keeps increasing with compound interest.
The most important thing you can do is to start early. The effects of compounding money an extra 10 years can be life-changing!
Here’s a simple example of the effects of compounding:
This is just an example, an 11% return over 30 years is almost unheard of unless you invested in a company like Altria Group (MO) that spun off companies like Philip Morris (PM) and Kraft (KFT). Then Kraft (KFT) spun off Mondelez (MDLZ) in 2012.
However, this makes the point I’m trying to get across. There’s a vast difference in the amount of money that has compounded over a 40 year period compared to starting later in life. Investor A has $787,176 when investing only $5k per year! Yes, almost anyone can come up with $100/week to invest.
Starting just 10 years later at age 35 drops your entire ending balance by more than 50%! You still had 30 years of compounding but that extra 10 years more than doubled your final outcome.
1. Start Early
2. Save as Much as Possible
3. Consistently Invest.