Good morning & happy Monday!
“Compound interest is the eighth wonder of the world. He who understands it, earns it … he who doesn’t … pays it.”
Albert Einstein
Let’s talk about compound interest … one of my favorite topics in the world of finance!
Simply put, compound interest is the idea that your growth grows.
Let’s say I have $100,000 and it grows @ 8% in year 1 … at the end of that first year I have $108,000 … representing $8,000 of growth. (For those who want to follow on a calculator: $100,000 x 1.08 = $108,000)
In year 2 we start benefiting from compounding interest … let’s say that $108,000 grows by 8% … at the end of the 2nd year I have $116,640 … representing $8,640 of growth. (For those who want to follow on a calculator: $108,000 x 1.08 = $116,640). In other words, my $8,000 earned last year made $640 of additional interest in year 2.
This continues in year #3. $116,640 grows by 8% brining my balance to $125,971.20 … $9,331.20 of growth. (For those who want to follow on a calculator: $116,640 x 1.08 = $125,971.20)
For this example (and it’s only an example, no particular investment proposal here) I pull out my financial calculator and learn that at the end of 10th year my $100,000 would have grown to $215,891.50. That’s $115,891.50 of growth on $100,000 starting balance.
Remember in year 1 I made $8,000 in growth, by year 10, because my growth is growing, I made $15,991.04 in interest … more than twice what I made that first year … AMAZING!!!
If I keep plugging this info into the financial calculator I discover that
- after 20 years the value is $466,095.71
- after 30 years the value is $1,006,265.69
- after 40 years the value is $2,172,452.15
Since I’ve got my calculator out and am having such a good time (remember, I’m a nerd when it comes to this stuff ????) let’s take a quick look at that $2,172,452.15 figure at the end of the 40th year. It that grows by 8% I earn $173,796.17 in growth in year # 41. So, the initial $100,000 40 years later is making $173,796.17 in growth alone! See why Einstein called it the 8th wonder of the world? Amazing!
Now, compound interest is not all roses and rainbows … there is a dangerous side of this concept too. Those who borrow money can easily find themselves on the bad side of this concept and it can be virtually impossible to get out of. Next week we’ll dive into this.
It is a true honor to be your financial planning partner!