Compound interest is one of the biggest wonders of investing. Albert Einstein even called compound interest the eighth wonder of the world. So let’s dive into it.
In the simplest explanation, compound interest is interest earned on top of interest. Let's say we invest $1,000 and earn 10% interest in the first year. We would have $1,100 at the end of the year. Now, we let compound interest kick in. If we leave that money invested and earn another 10% interest in the second year, we'll end up with $1,210. That's an extra $10 on top of the additional $100 just for leaving our money alone!
Now, let's say we keep doing this for 10 years. We'll end up with $2,593.74! That's more than double our original investment, and we did nothing more than just starting with that original $1,000.
Taking this even further out, if we keep our money invested for 20 years, we'll end up with $6,727.50! That's more than six times our original investment of $1,000, all thanks to compound interest.
Now, let’s use bigger numbers to show how once you get the ball rolling how much momentum it really gets.
If we get to $50,000 invested and never put another dime of investment in what does that look like over 10 years?
Well, with $50,000 invested, earning 10% per year, after one year we have $5,000 of interest totaling $55,000. After five years we have $30,526 of interest totaling $80,526. And finally, after 10 years, we have $79,687 of interest for the grand total of $129,687 after 10 years.
That’s why Albert Einstein called it the eighth wonder of the world.
When thinking about compound interest, we also have to remember that the same principles apply for loans, credits, and other debts. When we borrow money, we're essentially paying interest on top of interest. That's why it's so important to pay off our debts as quickly as possible, to avoid getting caught in a cycle of compounding interest.
In conclusion, compound interest is a powerful force that can work for us or against us. By investing wisely and paying off debts quickly, we can use the power of compounding interest to build wealth and achieve our financial goals.