Compound Interest Can Make You Rich

“The most powerful force in the universe is compound interest” – Albert Einstein

If you truly want to become wealthy and have the ability to stay that wealthy, it is imperative that you really understand the concept of compound interest. Most people think of compound interest as purely a monetary thing. I don’t. I apply the compound interest theory to many other things, including business decisions, relationships and many other things in life. For this post though, we’ll just focus on compound interest in terms of monetary investments.

Compound Interest and Bank Accounts

I am not going to beat this horse to death. Chances are if you are reading this you are probably intelligent enough to understand the power behind compound interest to some extent. I will just reiterate a few examples to help you see how important it is to understand just how powerful it truly is.

Mike and Bob both graduate from high school at the same time. Mike goes into an apprenticeship program as a carpenter to follow in his father’s footsteps. Bob goes into an engineering program at a well known university.

Mike’s dad taught him to be frugal and always live within his means. Mike’s dad constantly preached about how important it is to put 15% of your income away to save for retirement. So, right from the start of his career as a carpenter, Mike started saving 15% of his gross wages for retirement. He earned $32,000 per year as a carpenter. So, he saved $4,800 from year one.

Bob, on the other hand, went to college so he could get the better job as an engineer. Bob succeeded in doing so. When he got out of college, he was able to land a position for $50,000 as an engineer. While in college, Bob also learned about compound interest. Like everyone says, Bob also began saving for retirement at the rate of 15% or $7,500 per year.

Thirty years later we see how the two boys made out. To eliminate some variables, let’s assume the boys both earned 9% interest every year. Mike who worked as a carpenter earning $32,000 per year was able to amass a retirement nest egg of over $945,000. Bob who worked as an engineer earning $50,000 was able to amass a nest egg of $920,000. What? How could a guy saving $4800 per year possibly have more than a guy saving $7500 per year? It is because Mike started saving four years before Bob. Mike already had nearly $22,000 in his account when Bob just started saving.

Imagine how much money you could have when you are sixty if you started saving 15% of your income back when you were a paper boy.

How much different does one percent make?

Over 30 years a 1% difference in your rate of return would have a huge difference in your nest egg. Ten thousand dollars would turn into about $132,000 after thirty years of earning 9% tax free interest annually. The same ten thousand would grow to become $174,000 after thirty years of earning 10% tax free interest annually.

How much difference does 5% interest make compounded over thirty years?

I have already shown you that over a period of thirty years, a $10,000 investment would turn into about $174,000 if it were to earn 10% interest annually tax exempt. The same $10,000 would turn into more than $662,000 if you earned 15% every year.

What if you started compounding from the day you were born?

Imagine if your parents had given you $10,000 on the day you were born and it grew tax exempt until you were age 65. Know how much that would be worth on your 66th birthday? Assuming a modest 8% interest rate it would be worth almost $1.5 million. We could all retire as millionaires. If you happened to average 10% over those sixty five years you would accumulate a total of nearly $5 million. I bet you are now questioning why the government doesn’t allow us to do this for our children.