Compound interest is the addition of interest to the principal sum of a loan or deposit, or in other words, interest on interest. It is the result of reinvesting interest, rather than paying it out, so that interest in the next period is then earned on the principal sum plus previously-accumulated interest.
Let’s play around with compounding interest:
- You put $10,000 dollars as an investment fund at age 20. You invest in a fixed deposit fund which returns 4% per annum. You forgot about it and then realized you had this fund when you are at age 60. Guess how much is it worth?
The final amount: $48,010.21, with a yield of 380.1% over 40 years.
Lets try another scenario:
You put in $10,000 dollars as an investment fund at age 20. You invest professionally either with good investment skills or with a professional fund manager (let’s just say he’s your good buddy) that basically gives a return of 20% per annum. You forgot about it (again) and then realized you had this fund when you are at age 60. Guess how much is it worth this time?
The final amount: $14,697,715.68, with a yield of 146,877.16% over 40 years.
Imagine, just $10,000, you get a return of 14 million dollars, by virtually “doing nothing”. (yeah you had to do some analysis and some orders but still… easier than working a 9-5 job??)
Now can you imagine, a simple fellow like Warren Buffett, at age 20 (1950), he started with $9,800. Today at age 86, he is worth 76.4 billion.
That meant that his interest rate averaged over 66 years was at 27%.
Can you beat Warren at his game? 🙂