Compound Interest: The Eighth Wonder of the World

Einstein is rumored to have said it best: "He who understands it, earns it... he who doesn't... pays it." Compound interest is the engine of wealth building.

What is Compound Interest?

Simple interest is earned only on your initial deposit (principal). Compound interest is earned on your principal plus the interest you've already accumulated.

It creates a snowball effect: your money makes money, and then that money makes more money.

The Power of Time

Time is the most important factor in compounding. Starting early is far more powerful than saving more later.

Example:

Person A starts saving $5,000/year at age 25 and stops at age 35 (10 years total).
Person B starts saving $5,000/year at age 35 and saves until age 65 (30 years total).

Assuming an 8% return, Person A will likely have more money at retirement, despite contributing 1/3 as much cash, simply because their money had more time to grow.

Rule of 72

A quick mental math trick to estimate how long it takes to double your money:

Divide 72 by your annual interest rate.

At 8% return: 72 / 8 = 9 years to double.
At 4% return: 72 / 4 = 18 years to double.

Real Life Examples

Mrs. Williams

Teacher . $60k . 20% Savings

She starts investing $500/mo at age 25. By age 65, she has $1.7 Million (assuming 8% return). She let time do the heavy lifting.

Mr. Johnson

Average Joe . $90k . 10% Savings

He waits until age 35 to start. He invests $750/mo. He ends up with $1 Million. He put in more money than Mrs. Williams but ended up with significantly less.

Mr. Smith

Mr. Popular . $120k . 5% Savings

"I'll save when I'm older." He starts at 45. He has to invest $2,000/mo just to catch up to Mr. Johnson. He has to work 4x as hard because he forfeited the advantage of time.

See the numbers for yourself: