“Compound interest is the 8th wonder of the world” – Albert Einstein.
I’m not sure he actually said it, but an urban legend says so…
Anyway, you have to see some examples to really appreciate this wonder.
Suppose you have $1,000 to invest and you receive 10% interest on your investment every year. This means that after one year you get $100 and the total amount you have is $1,100.
You use this $100 to celebrate and know that next year you’ll have another $100, this is like magic, the mithical cornucopia or in English – horn of plenty. A little horn of plenty but still, you get $100 every year from this investment of $1,000. If you do it for more than 10 years you’ll actually get back the full investment and more money indefinitely!
Nice. Now let’s see what happens if you decide not to spend the $100 you got from the first year and add it to the investment.
The second year starts with $1,100 and at the end of the second year you get 10% of this amount or $110.
This is more than the $100 you got the first year, you could say it’s not such a big difference and you disregard the hole thing. I mean, you could use those $100 a year ago and what do you get for not spending them right then? A measly 10 bucks?
That’s the thing with compound interest, it is deceptive. You really need to swim against the currents to make it work. The world’s largest religion is against you (consumerism). A lot of people start with great intentions and plan to use compound interest to their favor only to be swept by the forces of life.
Imagine if your grandparents opened a modest investment account for you when your father was born. I know this is a weird idea but stay with me for just a few moments.
They knew it takes a lot of time or a lot of money to really free someone from the chains of modern slavery in a day job.
They decided to invest $100 each month for each of their yet unborn grandchildren. They studied the investment world and found a combination of investments that gave them 10% a year.
I know that $100 many years ago was much more valuable than $100 today, let’s pretend this is an inflation free world or that they didn’t actually invest $100 but the equivalent of today’s $100 with a smaller amount and the 10% they earn on their investment was a bit more to adjust the story.
So at the end of the first year they have $1,200 they start earning the 10% only after each whole year to simplify the calculation.
Let me now pull out a spreadsheet and show you how much you get as a gift when you’re 35 years old and they started 25 years before you were born.
The spreadsheet is here.
At 35 you will be so wealthy you wouldn’t believe it. You’ll have more than 3 million dollars!
Now, don’t blame your grandparents for not doing anything with this information, they probably didn’t read this blog back at the time, it didn’t exist 60 years ago. I know it’s hard to imagine but actually the internet itself didn’t exist.
So instead of bitching about your bad luck with your grandparents who didn’t set you out in life (which is a common reaction), the official moral of the story is –
You’re that grandparent.