Power of Compounding Interest
How do you turn $10,000 into more than $500,000? Time and patience. If you are at all interested in money or investing you probably already know about the power of compounding interest. Many stories have been written on this topic, but I feel that compounding interest is the true key to wealth, so I decided to write a little on the subject.
I’m not going to go into that much detail since if you’re reading this web page then you probably are already aware of the principle. For the people that have never heard of the subject, you can read up on the topic over at Wikipedia.org.
Now let me give you 2 quick examples. Say you decide to start investing early. You’re 25 and invest $10,000 in the year 2000. You leave the money alone and you don’t touch it until 40 years later or when you’re 65, and the money gets compounded at the end of every month. How much do you think that original $10,000 would be worth in the year 2040? You’d be surprised to find that it’s worth a whopping $537,006! That’s if you assume an average of a 10% gain over those 40 years which is possible.
Now, say you got started a little late and you didn’t start investing until the age of 35. You still invest the same amount of money, only this time you started just ten years later and left the money alone for 30 years. How much do you think it would now be worth? $198,373 is the answer. That’s a $338,633 difference just by starting 10 years later.
That’s pretty amazing, and that’s the power of compounding interest. The more time that you leave your money alone, the more it will grow. It’s really those last couple years that the money will grow rapidly. Visit Bankrate.com's Simple Savings Calculator to find out what various dollar amounts will be worth in the future when compounding interest is applied.
Lots of people understand and are using the principle of compounding interest to their advantage. In my opinion, it’s the greatest tool to achieving wealth. It doesn’t happen overnight, but if you want to be rich this is the way to get there. If you keep telling yourself that you’ll start investing in a couple of months, STOP! Go do yourself a huge favor, and do it now! You’ll be glad you did.
I’m not going to go into that much detail since if you’re reading this web page then you probably are already aware of the principle. For the people that have never heard of the subject, you can read up on the topic over at Wikipedia.org.
Now let me give you 2 quick examples. Say you decide to start investing early. You’re 25 and invest $10,000 in the year 2000. You leave the money alone and you don’t touch it until 40 years later or when you’re 65, and the money gets compounded at the end of every month. How much do you think that original $10,000 would be worth in the year 2040? You’d be surprised to find that it’s worth a whopping $537,006! That’s if you assume an average of a 10% gain over those 40 years which is possible.Now, say you got started a little late and you didn’t start investing until the age of 35. You still invest the same amount of money, only this time you started just ten years later and left the money alone for 30 years. How much do you think it would now be worth? $198,373 is the answer. That’s a $338,633 difference just by starting 10 years later.That’s pretty amazing, and that’s the power of compounding interest. The more time that you leave your money alone, the more it will grow. It’s really those last couple years that the money will grow rapidly. Visit Bankrate.com's Simple Savings Calculator to find out what various dollar amounts will be worth in the future when compounding interest is applied.
Lots of people understand and are using the principle of compounding interest to their advantage. In my opinion, it’s the greatest tool to achieving wealth. It doesn’t happen overnight, but if you want to be rich this is the way to get there. If you keep telling yourself that you’ll start investing in a couple of months, STOP! Go do yourself a huge favor, and do it now! You’ll be glad you did.
I think taxes and inflation are often forgotten in this calculations. People see that they can invest $10,000 at age 25 and might believe that they are more or less set for retirement.
With inflation something like 3%, your 10% gain is closer to 7%. And then you'll pay taxes on all the gains (unless you put it in a Roth IRA or something like that) which could be a quarter of the money.
I did the math and switched the 10% to 7% to reflect the final amount "today's dollars" and after 40 years, I get $163,114.11. Then after taking off the taxes (assuming 25%), the total is $114,835.58.
It's still a 11x gain, but I don't know many people that would try to retire on $114K nowadays. I don't mean to bring people down, but just want to make sure they are prepared to continue to think about retirement.
Posted by
Lazy Man And Money | October 20, 2006 6:13 PM
Lazy Man and Money, you do bring up a good point, and I've always noticed that the top financial magazines usually don't mention the taxes or inflation when calculating the final value of the money invested. Or, if they do mention it, it's very brief.
Along with the taxes and inflation, there are also the costs associated with owning a stock or a fund. My main goal of writing this article was to mention how you could make a lot of money with a little investment and to talk a little about the power of compounding interest.
I do understand the taxes and inflation, and my main goal was not to deceive people into thinking that they would be set for retirement. People should have a couple of different retirement options. 401k, Mutual Funds, Stocks, CDs, Bonds, etc.
One should think about the taxes and inflation but they shouldn't focus on that. The biggest thing is to actually get out there and start investing. The more you wait, the less you earn in the end.
The magic of compounding interest really shows itself in the last couple years that you own the investment. When you have a 10% gain on $1,000, it's not that much. But, when you have a 10% gain on $100,000, that's a lot of money.
Posted by
David B. | October 21, 2006 2:03 PM
You could also lose it all. The only place your going to get close to 10% is the stock market. Whether it's stocks, bonds, mutual funds,realestate funds, any fund that is out there now. I agree you need to invest but do so very wisely. Research and get with a very credible company, like trowe price.
Posted by
Brad | January 06, 2007 12:18 AM
I do not believe in investing in the stock market. You are taking a chance with your retirement money. I have been investing for 13 years with three different reputable companies. I could have made more money in a savings account or leaving the money in my pillow. There are no guarantees with mutual funds or stocks or anything else to do with the stock market. A reputable company on day could be filing bankruptcy the next. If you do not believe in the stock market a good read is the Rich Dad Poor Dad series.
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