The Power of Compound Interest
By Nathan on The Capital
“Compound Interest is the Eight Wonder of the World” and “compound interest is the most powerful force in the universe” are supposedly two quotes by the Greatest Scientist who ever lived Albert Einstein. Whether he actually said those things seem unimportant to me because compounding is so powerful.
Would you believe me if I told you that that you could invest $10,000 today and in 50 years' time it could be worth over $1 million without investing a single cent more?
It’s true and that is the power of compound interest.
How to turn $10,000 into $1 million.
According to Vanguard, the Australian Stock Market has grown on average by 9.5% per year since 1970. $10,000 invested into the Australian Stock Market today would grow to over $1 million in 50 years' time if it grew at 9.5% per year. That is investing $10,000 today and not adding a single cent.
Below is a graph showing how your money would grow thanks to compound interest.
You can see for yourself at moneysmart.gov.au.
What is Compound Interest?
Compound Interest is essentially interest earned on your interest.
Let’s say you have $10,000 saved in a bank account which is earning 10% per year.
After one year your $10,000 will have earned $1000 in interest.
$10,000 x 10% = $1000.
This means you will now have $11,000 in your account.
Another year later you will have earned $1100 in interest. ($11,000 x 10% = $1100).
Your account will hold $12,100
The year after that you will earn $1210
Every year you earn more in interest because the previous year’s interest grew your balance.
Compound interest causes your money to grow at a faster and faster rate over time.
Your money will grow exponentially.
Why it is important to start investing Early
Compound interest becomes more powerful the longer it has to grow. How much do you think $10,000 will be worth in 50 years but instead of investing the money now you wait 10 years.
This will mean your money only has 40 years to compound.
Your $10,000 will only grow to around $440,000.
That is a difference of nearly $700,000 just because you chose to wait 10 years.
That is the difference between starting to invest at 25 and starting to invest at 35.
Important note. This article is going on past performance. Please remember that past performance is not a reliable indicator for future performance. The Australian Stock Market may not grow at 9.5% per year. It might only grow at 5% or less, it could grow at 15% or more.
A Comparison of 2 investing plans
Let’s compare two investing plans.
Jim is 20. He is going to invest $10,000 every year for the next 5 years into the stock market and then just let his money grow until he retires at 65.
Bob is also 20. Instead of investing now he is going to grow his income, save and then invest $10,000 every year until he retires at 65.
Jim will invest $50,000. Bob is going to invest $350,000. Who do you think you have more money at the age of 65.
Jim’s money will grow to $2,873,803 after investing $10,000 every year for the first 5 years, and then just letting the money grow for the next 40 years.
Bob’s money will grow to $2,656,489 after waiting for 10 years and then investing $10,000 every year for the next 35 years.
Even Bob Invested an addition $300,000 he ends up $217,314 poorer.
This just shows that it is more important to invest early and that you don’t need to invest large sums of money to grow your wealth.
Summary
- Albert Einstein considered compound interest to be the most powerful force in the universe and the eighth wonder of the world.
- The stock market could turn $10,000 into $1 million within 50 years.
- Compound Interest is essentially interest earned on your interest.
- Compound interest becomes more powerful the more time it has to act.
- Be like Jim. Start Investing as early as possible.
