Compound interest – Albert Einstein called it the 8th wonder of the world.
And there’s a good reason why.
It’s hard to dispute the power that understanding and harnessing compound interest has on wealth creation.
Earning interest on interest is amazing. The same can be said for investment returns.
The compounding effect of reinvesting, and earning returns on your returns.
It’s why you should start investing as soon as you can.
I’ll show you the power compounding has on longterm investment returns.
For each example, I’m going to assume an initial lump sum of $10,000 invested, regular investments of $2,000 per month and an average annual return of 9% (The ASX has averaged 13.21%).
I’m also going to assume that all returns are reinvested and a retirement age of 60.
Investing at aged 50.
At age 50 you’ll have 10 years to let compounding work its magic.
You’ll have contributed $240,000 in monthly deposits.
Your investments would return $161,542 and you’ll have a total of $411,524.
Not a bad start.
Investing at age 40
You’ll now have 20 years of regular deposits and compounding.
A total of $480,000 will be contributed in monthly deposits.
You’re now starting to see the real magic of compounding. You’ll have earned $905,865 and have a total of $1,395,865.
Investing at age 30.
If you start at age 30, you’ll have a real advantage. 30 years of regular deposits and compounding is going to set you up great!
You’ll have contributed $720,000 in monthly deposits.
Through the effect of compounding, you’ll have earned $3,078,793! You will now have a total of $3,808,793.
Not a bad stash of cash to retire on!
Investing at age 20.
Now for any superstars that started their investment journey at 20, you’ll have something special at age 60.
You’ll have contributed $960,000 in monthly deposits.
If you’ve been disciplined for 40 years, compounding will truly be magical.
You’ll have earned $8,753,740 and be sitting on a cool $9,723,740.
Compare the difference
Now, this is obviously a simple explanation based on a few assumptions. Throughout life and investing there are always up’s and down’s.
But it’s a great example showing the power of compounding over a long period of time.
P.S. If you want to play around with some number, check out the Chatting Fire income replacement calculator.
Interested in Financial Independence Retire Early? Join the discussion at Chatting FIRE forum.
Calculations and graphs courtesy of MoneySmart.gov.au