Why Albert Einstein loved compound interest
That’s a BIG rate of return, but it keeps the numbers round. Once you understand what compound interest means, it can change your perspective on money and investing. This famous quote from Albert Einstein speaks to the significance of compound interest as a financial concept. Those are strong words from someone who most people consider a credible source on math-type stuff. Now if you are like most people, at first you might jump on the million dollar deal. But if you break out your calculator and double one penny for 30 days you will be amazed that on day 30 your penny would be worth over $5,000,000.
Basically, you never sell your stocks while alive, just borrow against them. BlackRock Global Equity income is another attractive fund. Its top holdings include big name blue chips such as Pfizer, Johnson & Johnson, Novartis and Glaxo. That compounding effect is even stronger than you realise.
- For the first couple years of my investing journey, I really didn’t fully comprehend what he was meaning when he said this.
- But what if Dad were nearly as good an investor as Warren Buffet who averaged a 21.5 percent annualized return?
- The concept is that when you earn interest in X amount of time, that next time period you’re going to earn interest on the principal AND the interest that you previously earned.
This can be done quite simply by opening a brokerage account, picking a S&P 500 ETF like SPY and then investing that money. After 10 years, you are earning $23.58 in interest when you only earned $10 in interest in year 1. The rate is the same (10%), but you are earning it on more money each year. Albert Einstein once said “Compound interest is the eighth wonder of the world. He who understands it, earns it; he who doesn’t, pays it”. While some people question whether the quote was in fact from Einstein, the power of compound interest is unquestionable.
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A quick example is that if you invest $1000 for one year at a 10% return you will have $1100 at the end of the year. After earning this $100 you decide that you want to do the same thing for the next year and reinvest your principal ($1000) and return ($100) and earn 10% again. This year instead of earning $100 dollars you earn $110. The 10 extra dollars are due to compounding as you have earned a return on your return. This doesn’t seem like very much but the secret with compounding is to amplify it by investing for long periods of time.
QI hypothesizes that the statement was crafted by an unknown advertising copy writer. Over the years it has been reassigned to famous people to make the comment sound more impressive and to encourage individuals to open bank accounts or purchase interest-bearing securities. That’s why you must employ a system like Dollar Cost Averaging. When you decide to put the same amount of money into the market every month, you automatically buy less when the market is up and buy more when it’s down.
Compounding interest can create millionaires from average people.
All else equal, that should result in a greater long-term return given the greater compounding effect. The original example was the S&P 500 which does pay dividends. You could pursue this strategy but would suffer lack of diversification.
Compounding interest teaches and rewards discipline.
Having a longer investment horizon is important as the effect of compound interest may not be obvious in the short term, but will be realised over time. While young people may not have much money to invest with, time is on their side and they are in the best position to take advantage of compound interest to accumulate wealth. Years ago I was reading an article that first exposed me to the Rule of 72 which is the simplest way to calculate compounded returns. This can usually be solved in your head if you remember your math tables from elementary school (maybe they don’t teach these any longer).
Albert Einstein – Compound interest
Compound interest is the concept of earning interest on interest. Let’s say you put $100 into a savings account and that balance grows to $105 by virtue of earning interest. From there, you’ll be able to accrue interest on not just your initial $100, but rather, on $105. First, most middle- and upper-middle income people and even most people in the top 20%, such as my wife and me, hold our stocks in IRAs. So the taxes are paid at the end, but the accumulation is tax free. It is the same story in the United States, Mr Dowding says.
If you invested US$10,000 (Dh36,731) at 3 per cent a year, but withdrew all the interest every year, you would have $16,000 after 20 years. But if you allowed the interest to compound, your savings would grow to more than $18,000. And when savings rates finally revive from today’s miserable lows, the effect will be even more powerful. In the two examples above, it was assumed that interest compounds annually. Compounding means how often the interest is added onto the principal amount.
Without debt, you’re nearly at $1.07 million while the debt scenario isn’t even at $800K. In total, you’re not only paying interest but your opportunity cost is $283K worse than if you didn’t have any debt at all. One of my favorite compound interest examples that I like to use is the power of making small changes in your everyday life and then sitting back and watching the money compound like crazy. To me, the #1 easiest change to implement is simply to stop going out and buying lunch every single day at work. That first year you did make $500, or 10% on your $5K investment.
This year, you’ll be earning interest on $102 (original savings plus the interest earned). That might not seem like much, but understanding that simple fact can have a major impact on your financial success. A property and personal finance writer, Nick Bendel covered property, loans, credit cards, superannuation, and other bank products. Nick has previously written comprehensive income definition for The Adviser, Mortgage Business, Lifehacker, Business Insider, Yahoo Finance, and InvestorDaily, and loves getting elbow-deep in the latest ABS, APRA and RBA data. When company profits are growing, they raise their dividends to reward investors. Some companies strive to do this year after year because they see it as a mark of a well-run enterprise.
That’s a BIG rate of return, but it keeps the numbers round. Once you understand what compound interest means, it can change your perspective on money and investing. This famous quote from Albert Einstein speaks to the significance of compound interest as a financial concept. Those are strong words from someone who most people consider…