Compound Interest: The Eighth Wonder of the World
The trouble with getting people to start investing early is that humans are not good at delayed gratification. Especially now, people always need the coolest thing immediately, nicest cars, nicest homes, nicest gadgets. All the while forgetting to save along the way. It doesn’t help that the first decade you do start saving and investing the results don’t seem like much. It’s hard for people to understand compound interest and what that looks like in the real world.
I recently read about this thought experiment posted by Thomas Kopelman that can help illustrate compound growth. Imagine it’s 10:00 am and you see a pond with a single lily pad. The amount of lily pads doubles every minute and completely fills the pond by 11:00 am. At what time is the pond half full of lily pads? Now at first glance without much thought you might think 10:30 am. Seems logical, half full = half the time. However this is compound growth we’re talking about, not linear. The real answer is 10:59 am. If the lily pads are doubling every minute then 1 minute before it’s completely full, it’s half full.
When we see how this plays out in terms of investing in the real world it’s really interesting to see exactly how much wealth is created in the later years vs early on. Let’s say we have an individual who’s saving $500/month from age 25 to age 65. We’ll assume they get an 8% average annual return for those 40 years.
At age 35 they have this amount in their account: $91,473. Pretty good but $60,000 of that is the money they contributed themselves only $31,473 or 34% of that is interest earned.
Here is what it looks like at age 50: $475,513 total in his account. Of that they only contributed $150,000 and the other $325,513 is from interest! Almost 70% of the account value is now solely due to interest earned.
If we continue to age 65 the investor now has an account balance of $1,745,503! Of this amount they personally saved only $240,000. This means that over 85% of the wealth this investor created for themselves was due to compound interest, a staggering amount that can only be attributed to time in the market. And, just like the lily pad example over 70% - almost $1.3 million! - of the investors total wealth was earned after the age of 50. I want to emphasize just how crazy that is, over 70% came in the last 15 years. This is why it is so important to not get rattled by short term moves in the market, stay the course and focus on the long term because when you do the results can be magical.
Let’s compare that to someone who doesn’t start investing until age 35, however contributes the same $500/month and gets the same 8% return. By age 65 they would have only $745,179. Over a million dollars lost by waiting just 10 years! For reference, to achieve the same amount of money as the person who started early, the investor that waited has to save $1,171 per month - over double the investor who started early!
Talk about time is money.
If you’re interested in getting compound interest started but not sure where to begin, reach out to me or schedule a quick chat today! I would love to help you get started on the path to financial independence!
Will