“The greatest mathematical discovery of all time” – Albert Einstein
Some of the world’s greatest minds have uncovered this secret.
It’s one of the most important lessons you can learn as an investor. Compounding is found in many places in the natural world. And in finance, compound interest makes millionaires.
To start, interest is simply the cost of borrowing money.
Banks for instance hold and borrow your money. Banks use the money to lend to folks that need it now… then down the road the borrowers must pay the full amount back plus some (interest).
For example, Joe wants to buy a nice TV. He then borrows $1,000 from the bank. At the end of the year he has to pay back $1,000 plus $100 (10%). The extra $100 is the cost of borrowing the money and it’s called interest.
Now the bank has $1,100. If it lends out the $1,100 at 10% in year two, the interest payment will be $110. The bank would then have $1,210. In year three a 10% interest payment would be $121. The bank would have $1,331.
Each interest payment is put back to work. That allows banks and investors to earn a little more each year. It seems small… but over many years it amplifies. The table below shows how large it will grow over time.
In 100 years a $1,000 investment compounding at 10% interest will be over $13 million! The interest payment alone in year 100 would be over $1 million.
Time amplifies the effects of a few percent. That’s why it’s important to look at the small numbers. It’s easy to ignore long-term results but smart investors know it’s well worth their time.
“Compound interest is the eighth wonder of the world. He who understands it, earns it … he who doesn’t … pays it.” – Albert Einstein