My wealth has come from a combination of living in America, some lucky genes, and compound interest.Warren Buffett
If you are saving or investing money, it’s important to learn how compound interest works. It will earn you more than you think.
As I have previously mentioned, I love a game of monopoly, so with a nod to the great game let’s imagine a scenario where you win £1000 in a beauty contest.
Congratulations, you beauty.
You have monk-like discipline and put it all into a savings account paying 5% per year and leave it for 20 years.
By calculating the simple interest you might think that you will end up in 20 years with £2000 (5% x 20 years = £1000 + your initial £1000). Right? Wrong.
Because the 5% interest is calculated on your initial £1000 as well as your interest pile that is steadily growing over the years, you actually end up with £2,713!
I meant just look at the state of this graph. All aboard the green line to party town!
So what to do with this information?
In our example, an extra £713 over the course of 20 years doesn’t sound like much. Not bad for beauty contest winnings, but not life-changing.
But, where the benefits of compounding really kick in is with long term regular saving and investing. Say you invest £5K per year and get a return of 5% per year, once you get past 25 years, you begin to see exponential growth.
So, if you are saving for the future you should start now, literally today, and let compounding take some of the strain for you.