The Money Club for Young Adults
The Power of Compound Interest
As you can see from the chart below, compound interest is not very exciting in the short term. However, it becomes a very powerful force after years of patience and
discipline. Earning interest on your interest will result in exponential growth in your investment over time.
Carl Richards
“Compound interest is the eighth wonder of the world. He who understands it, earns it … he who doesn't … pays it.” Albert Einstein
4 Key Takeaways
1.) Time: the earlier you start the sooner you gain the advantage of time.
2.) Rate of Return: the higher the better.
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our investing section will help.
3.) Reinvest your earnings: don't spend them; instead, let them compound.
4.) Capital preservation: don't take excessive risks that can lead to large losses.
Let’s look at a real world example.
We have three kids. The year our third was born (2003) we opened a group RESP and we contributed $2,000 for each child = $6,000 total. As per RESP rules, the government added 20% = $1,200. So we started with $7,200. We never made another contribution. Today that RESP is worth $104,000. Through the magic of compound interest (and tax free compounding) our $7,200 has mushroomed into $104,000 in 15 short years. Compound interest is very exciting to us!
Starting Balance = $7,200; May 2003
Ending Balance = $104,000; August 2018
Time = 15 year and 3 months (183 months)
Compound rate of return = 19% per year
Exercise 1: If you start with one penny and double it every day for 30 days, how much will you end up with? Click here to find out
Rule of 72: a simple way to determine how long an investment will take to double in value, given a fixed annual rate of interest.
How? Divide 72 by the annual rate of return to get a rough estimate of how many years it will take for the initial investment to double.
Exercise 2: How many years will it take for an investment to double in value if it earns:
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10% per year? (A: 7.2 years)
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7% per year? (A: 10.2 years)
Exercise 3: two friends, Ben and Arthur, are the same age. They both earn 12% per year on their investments.
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Ben, starting at age 19, invests $2,000 each year for 8 years and and then stops (total contributions = $8,000).
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Arthur, starting at age 27, invests $2,000 each year for 39 years and then stops (total contributions = $78,000).