The Strongest Force in the Universe
Anytime you can quote Albert Einstein to help make a point it’s a huge bonus. Albert Einstein called compound interest the eighth wonder of the world, the strongest force in the universe, and the most powerful thing he has ever encountered (clearly he never encountered the determination of my 5 year old when he wants a cookie).
Warren Buffett, is the world’s most famous investor, and attributes his $80+ billion net worth to just the following 3 things:
Lucky genes
Being born in America
Compound interest
Again, compound interest plays a starring role. So, what’s all the fuss about compound interest? We will explore below and help you understand why you want the strongest force working for you and those you love.
Compound Interest Defined
What is compound interest? Simply put it’s when your interest earns you additional interest. It sounds simple but it’s effect (crucially over time) is incredible.
Here is a Simple Example:
Investor A invests $10,000 dollars and earns a 10% rate of return each year.
Investor B invests $10,000 dollars and earns a 10% rate of return each year.
The only difference between the two investors is that Investor A keeps the $1000 earned each year in a safe deposit box, but investor B re-invests the $1000 earnings along with the original $10,000 and so the following year $11,000 is earning interest.
It may not seem like a big deal but as you will see with time it can be powerful.
Including the original $10,000 invested here are the results:
As you can see, with time, compound interest is phenomenal. It’s like the mighty Sequoia tree. They are over 250 feet tall but started as a seed the size of a pinhead.
How Compound Interest Works
Here’s the simple formula for compound interest: P(1+i)t
P - the principle, or the original $10,000 in the example above
i - the interest, or the 10% value in the example above
t - time, which is the number of years in the example above
As you can see, “t” is an exponent which is why after longer periods of time the growth is literally exponential.
Real Life Example
Remember Warren Buffet: He’s worth over $80 billion. To put that in context, he could buy 80,000 homes that each cost 1 million dollars. If he bought a million-dollar home every day it would take him 219 years to spend all of his money (I’m certain he’d like me to point out that he’s giving almost all of his wealth to help the poor and needy through the Bill and Melinda Gates Foundation). So back to compound interest, Warren Buffet is 89 years of age and do you have any idea what percentage of his wealth came after he was 52 years old? Any guesses, 50%, 65%, 75%…. try 99%! 99% of his wealth came after 52. That’s the power of compound interest!
The stock market is a device for transferring money from the impatient to the patient.
— Warren Buffett
More Realistic Example
Finally, to bring it back to our reality, what if you only made $50,000/year for your entire working life between age 25 and 65. You never received a raise but you were able to save 10% of your money each year. If you averaged a 10% rate of return how much would you have saved at retirement?
With compound interest the $200,000 you put away will become $2.2 million!
At a 5% draw down the person could spend $110,000/year. Or better yet, they could retire early from a job that never gave them a raise.
Key Takeaways
Compound interest is when you earn interest on your interest. Your original investment earns interest and is reinvested so it can compound.
The key factors are the money invested (principle), rate of return (interest), and time (which has the largest effect).
If you invest $5,000/year from age 25-65 ($200,000 total) and earn an average rate of return of 10%, you will have over $2.2 million.
99% of Warren Buffet’s $80B net worth came after he was 52 years old.
Conclusion
Compound interest truly is one of the most significant forces in the universe when it comes to building wealth. If you, your family, or friends aren’t sure they are doing everything they can to have this force work for them, please contact me to schedule a time to sit down.
Resource:
https://www.businessinsider.com/facts-about-warren-buffett-2016-12
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. They hypothetical examples listed above are not representative of any specific situation. Your results will vary. The hypothetical rates of return used do not reflect the deduction of fees and charges inherent to investing. Investing involves risk including loss of principal. No strategy assures success or protects against loss. The economic forecasts set forth in this material may not develop as predicted and there can be no guarantee that strategies promoted will be successful.
