Magic of Compound Interest

According to Einstein, the greatest invention in human history is compound interest. Yet compound interest remains a mystery to most people until they have seen it in action. Who can believe that it doesn’t really matter how much you save but for how long you do so. The value of time is something every investor/person needs to understand and impress upon there children. After all, who has more time than the young?

Compound Interest is defined as interest that is payed on the original sum plus all of the previously earned interest. This means that if you invest any amount it will continuously grow at an ever accelerating rate. Perhaps you have the seen long term charts from various asset classes. In every long term chart it always seems that the line starts almost flat and then skyrockets up as it gets closer to the current date. This occurs because of compound interest. At every cycle an investment is constantly earning more interest than it did in the previous cycle.

One commodity that every person lacks is time. In the grand scheme of things we humans do not have a very long lifespan. Every moment should be considered sacred as you will never get it back. Due to the almost magical ability of compound interest time is also sacred in the investment world. Every moment a person neglects to start saving could literally cost them a fortune.

The following scenario demonstrates the value of time and compound interest. Assume two individuals, Jack and Jill, both went to high school together. After high school Jack decided that he did not wish to continue school. Jack obtained a construction job and for the next few years investing the majority of his pay. Let’s assume he invested $1500 a month for ten or so years and then never invested again. Jill on the other hand loved school and decided to obtain a Masters in here favorite subject. She got a later start than Jack, 10 years to be exact, but was able to invest $2500 a month until she was 65 years old.

Over the course of their lives Jack invested $180,000 while Jill saved over $1.1 million. Whom do you think would have more money at the age of 65? Even though Jack only invested a small amount he was easily able to keep up with Jill’s greater earning power due to the power of time. When they turned 65 each would have about 12 million dollars.

The above example was intended to impress upon you how starting to save now, not tomorrow, not next year, but today is paramount. Every day someone fails to start investing they are literally throwing away a fortune. The problem is even made worse when you consider one time tax free accounts such as a Roth IRA. Unfortunately, humanity always seems to have an excuse and we are the ultimate procrastinators. I know I procrastinate when it comes to mowing the lawn but not when it comes to my future.