Compound Interest: The Magic Snowball That Grows and Grows
Compound Interest: The Magic Snowball That Grows and Grows
Compound interest is the eighth wonder of the world, or so the saying goes. It is the mechanism by which your money earns money, and then that earned money earns money of its own. Over time, the effect becomes exponential.
Key sources: "The Little Book of Common Sense Investing" by John Bogle, "The Intelligent Investor" by Benjamin Graham.
How It Works
Invest $1,000 at a 10% annual return.
- Year 1: $1,000 + $100 = $1,100
- Year 2: $1,100 + $110 = $1,210
- Year 3: $1,210 + $121 = $1,331
The interest grows each year because it is calculated on a larger amount.
The Rule of 72
Divide 72 by the annual interest rate to estimate how long until your money doubles.
At 10%, doubling takes about 7.2 years. At 6%, it takes about 12 years.
Why Starting Early Matters
Two people save $5,000 per year at an 8% return. Sarah starts at 25 and saves for 10 years. Tom starts at 35 and saves for 30 years. At 65, Sarah has approximately $787,000. Tom has approximately $611,000 despite contributing three times as much.
Time is the most powerful factor in investing.
Key Takeaways
- Start now. Time is your biggest advantage.
- Be consistent. Small regular contributions matter more than large irregular ones.
- Reinvest earnings. Let the compounding work.
- Be patient. Compound interest is unremarkable at first and explosive over decades.