Compound interest is loved by some of the smartest minds ever including Albert Einstein and Warren Buffet. Compound interest is how you are able to retire wealthier than you thought possible. If our education system was smart compound interest would be an entire class. Instead we get pointless classes like calculus and anthropology. Awesome.
If you want to earn the highest return in your portfolio you need to understand the importance of compound interest. By utilizing it you will be able to much larger net worth than if you saved your money in a savings account.
What is compound interest?
Compound Interest is interest that is added to the principal of a deposit. The added interest can then earn interest.
Who benefits from compound interest?
Everyone! Seriously whether you are investing $100 dollars or $1 million dollars.
- Anyone can benefit, no need to be a wall street guru. If you invest in the stock market over time you will use compound interest.
- The longer your money compounds the more you will earn. Money that grows at 6% would double in 12 years. In 24 years it would be worth four times as much.
Why does compound interest matter?
If you had $1,000 initial principal (initial amount) and received 20% interest rate per year you would have the following balance.
Initial deposit: $1,000
- Interest rate: 20%
- 1st year: $1,200
- 2nd year: $1,440
- 3rd year: $1,728
- 5th year: $2,488
- 10th year: $6,191
- 20th year: $38,337
- 30th year: $237,376
This example assumes that you do not invest more than $1,000. After 30 years you would have gained $236,376 dollars or 23,637% increase. This is the reason that you need to think LONG TERM instead of cashing out during a bad week or month in the stock market. Of course few (if any) investments will return 20% over 30 years. Twenty percent is used to help illustrate the growth potential of a $1,000 investment.
Roth IRA Compound Interest Example
- 29 year old makes $5,500 initial contribution.
- Forgot to invest anything, so the $5,500 sat in cash.
- Continues to make $458 monthly contribution ($458 x 12 = $5,500 = maximum annual contribution for Roth IRA).
- Invests for 30 years.
- Never withdraws money prior until 59 years old.
- Averages 8% annual return.
Total Contribution Amount: $165,000
Total Amount: $792,446.64
The other $328,192 was gained from compound interest! You only contributed 22% of the entire amount. Compound interest was the reason your investment more than quadrupled in three decades. A Roth IRA has already been taxed, so when you retire you are able to keep all $792,446 dollars.
This example was based off of a 8% return, historical market returns are 7-9%. Here is the breakdown with 7, 9 and 10% returns.
- Example with 7% return: $603,387.45
- Example with 9% return: $919,498.68
- 10% is over a million dollars!
Find a way to start saving now instead of waiting until the future. By taking advantage of compound interest you will be able to retire with significantly more in the bank. Start now, thank yourself later.